- Qualified retirement plans date back to before the Employee Retirement Income Security Act (ERISA) was passed in 1974. However, that act defined much of the rules and regulations that govern plans today. One significant aspect is the method and treatment of distributions from plans. There are numerous types of distributions, some of which are rollover eligible, and some which are not.
- Distributions such as plan loans, hardship withdraws or mandatory required distributions are not rollover eligible. The reason for this is simply because the government wants to collect taxes on these distributions and a rollover prevents that from occurring. However, several types of distributions are rollover eligible, such as a complete account distribution when you leave your company, become permanently disabled or if you die. There are are two ways in which a rollover may occur: a direct rollover to another qualified plan or an IRA, or an indirect rollover. A direct rollover is one in which the current trustee or custodian of your retirement account sends the rollover directly to your new account--you never see or touch the funds. An indirect rollover achieves the same result, except you receive the check in the mail first and must deposit it in your new account.
- A direct rollover has no time constraints since the rollover funds are sent directly from the previous trustee or custodian to your new trustee/custodian/IRA. Whether it is a 401k, IRA or other qualified plan, you have 60 calender days (not business days) to deposit the check into the new account. If you miss the date, the entire distribution will be taxable, including a penalty. Some participants have found this to be a good source of short-term funds; you would essentially have a 60-day interest-free loan. It makes sense, but there are numerous examples of participants that spend some of the money thinking that other money will come in to replace it, and it doesn't--so tread carefully if you're considering an indirect rollover.
- Rollovers are a critical part of the defined contribution retirement system. They are what make the accounts "portable," one of the biggest factors in getting employees to join these plans. Without this feature, you would be taxed on the amount you've contributed every time you left a company. Since today's workforce is much more mobile than in the past, that would only compound the problem of Americans without enough retirement savings. Oftentimes, an employee will request a cash payment. Once that is done, the money is out of the system and taxed in the current year, it can never be put back into a 401k plan again. In terms of trying to accumulate large balances for retirement, doing this means taking a big step backward.
- Rollovers should always be considered first, and more specifically direct rollovers. In some cases, the receiving plan won't allow them for any number of reasons. The most common is that the receiving plan is a 401k and you are rolling your money out of another plan that isn't clearly a qualified plan. For instance, if the name of the old plan was Joe's Paint Shop 401(k) Plan, you would be pretty certain it was qualified plan. But what if it was Joe's Paint Shop Retirement Plan? The receiving plan just couldn't be certain. In those cases, the receiving plan often requires a copy of the plan's IRS Determination Letter to be mailed in with the check. So, you would need to request an indirect rollover and ask for a copy of that letter. In either case, a rollover should always be considered before a cash payment.
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