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Dr. Don Taylor, CFA, Bankrate.com advice columnist Avoiding withholding on rollovers

Dear Dr. Don,
How can I avoid the 20 percent withholding trap when rolling over my retirement account into a traditional IRA? I would also appreciate any help on which bank or financial institution to deposit the money into for the best returns and least amount of fees and penalties.
Thank you,
-- Gail Gingerly

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Dear Gail,
Avoiding the withholding trap is easy, just move the money from your retirement account to the traditional IRA as a "trustee-to-trustee" or direct transfer. If the retirement plan writes a check in your name it will be subject to mandatory withholding. Your employer's retirement plan is required to provide you with a direct transfer option. Here's how that is discussed in IRS Publication 590, Individual Retirement Arrangements.

Before making an eligible rollover distribution, the administrator of a qualified employer plan must provide you with a written explanation. It must tell you about all of the following:

    Written explanation to recipients
    Your right to have the distribution paid tax free, directly to a traditional IRA or another eligible retirement plan.
    The requirement to withhold tax from the distribution if it is not paid directly to a traditional IRA or another eligible retirement plan.
    The tax treatment of any part of the distribution that you roll over to a traditional IRA or another eligible retirement plan within 60 days after you receive the distribution.
    Other qualified employer plan rules, if they apply, including those for lump-sum distributions, alternate payees and cash or deferred arrangements.
    How the plan receiving the distribution differs from the plan making the distribution in its restrictions and tax consequences.

Contact the plan administrator if you have any questions regarding this information.

The Boomer Bucks article "Overcoming rollover fears and anxieties" is recommended reading too.

It's easy enough to find an account provider that will charge low or no annual fees. While fees are important, decide how you want to invest the money first and then look at economical places to hold the account. 

Scottrade, for example, offers a no-fee IRA brokerage account with no set-up fees, no annual fees and no termination fees. An IRA that is a bank account is likely to have low or no annual fees. Mutual-fund families often waive annual fees once an account/investment relationship attains a certain dollar value. Don't let a $30 annual account fee determine where you're going to hold your money.

In general, you can chose between a bank account, a brokerage account or an account held directly with a mutual-fund family. Since most banks now also have brokerage services in their offices, make sure you know which you're opening if you open an account with a bank. Asking if the account is FDIC insured is a good litmus test.

You'll decide between investing in stocks, bonds or cash -- or some combination of the three. Cash is financial shorthand for money-market investments. You can invest in individual investments or buy mutual funds that are professionally managed investment portfolios.

If you're thinking about investing in a brokerage account or with a mutual fund family then you need to gain some knowledge about investments. My recommendation is for you to spend some time in the Investing Classroom at Morningstar.com. It's free and a few basic classes will help you make much better investment decisions.

Penalties come about mostly from taking distributions out of your retirement account that aren't qualified distributions.  These early distributions result in you paying a 10 percent penalty tax. Early distributions of tax-deferred earnings also are treated as ordinary income and subject to taxation at your ordinary income rates. 

If you're not planning to take early distributions, then penalties shouldn't be an issue. The SmartMoney University IRA Rules Super Page provides a nice overview of potential penalties and taxation of early distributions.

Editor's note: Dr. Don has a no-fee IRA account with Scottrade.

To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "Financing a home," "Saving & investing" or "money."

Bankrate.com's corrections policy-- Posted: March 28, 2007
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