A rollover occurs when the money in one Individual Retirement Account, or IRA, is transferred to a different IRA. The term also refers to the transfer of funds from a qualified retirement plan (a plan that meets certain federal regulatory requirements and is thus eligible for favorable tax treatment) to an IRA or to another qualified retirement plan. There are a number of specific rules regarding the withdrawal of funds from a tax-sheltered account or transferring them to a similar account. These rules are designed to discourage the use of the money for any purpose other than what it was originally intended for – retirement income.

Rollovers between IRAs are allowed only once within a twelve-month period. If you own more than one IRA you may initiate a transfer from each IRA once every twelve months. However, transfers between funds within the same family of mutual funds are not considered rollovers and therefore do not count. The rollover does not have to be made directly to the new IRA. From the date that funds are withdrawn from the original account, you have sixty days to make the deposit to the new account. Any funds not rolled over within that sixty-day period become taxable as ordinary income (but only to the extent that the funds consist of deductible contributions and earnings on any type of contribution, deductible or non-deductible), and a premature distribution penalty will also be applied. Additionally, if you change jobs and receive the vested amount of your former employer's qualified retirement plan, those funds will also become taxable unless rolled over into an IRA or another qualified plan within sixty days.

Other important rules that apply to rollovers include:

  • Only full or qualifying partial lump-sum distributions qualify for a tax-free rollover. The lump-sum distribution need not be made in one payment. Distributions are considered to be lump-sum as long as the entire balance of the account is paid out (even if in several payments) within one tax year. Amounts paid out in installments over more than a year do not qualify.
  • A partial lump-sum distribution may be rolled over, but any amount not rolled over will be subject to income tax (again, to the extent that it's made up of deductible contributions and earnings on any contributions).
  • Qualified plan distributions following a participant's death entitle a surviving spouse or beneficiary to the same rollover rules that governed the original participant.
  • Any rollover made from a qualified plan to an IRA or to another qualified plan must be made directly or it will be subject to a 20% withholding rate, even if the rollover occurs within the sixty-day time window. The definitive word is directly. In order to circumvent the withholding rate, the rollover must take place without the plan's funds ever being in the recipient's control – not even for one instant (in other words, you literally cannot touch the money). If such control does occur and the 20% amount is subsequently withheld, you must replace that amount from other sources or it will be subject to income taxation and a possible premature distribution penalty.

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