retirement

IRA rollover rules protect retirement

Don Taylorq_v2.gifDear Dr. Don,
I have an IRA CD that matured recently and is within the grace period for me to close or renew for the next 12 months. If I choose to renew, the interest rate is not very good.

I have obtained the direct rollover form from my present employer, so I can roll this IRA CD into my traditional 401(k) account. However, when I request a check (direct rollover) from my bank for the IRA CD that has matured, do I just request for the principal amount without the interest or with interest?


For example, if the principal invested was $1,000 and the interest earned was $20, do I request my bank to transfer $1,000 or $1,020 without having to pay tax? I am assuming I must have paid tax for the year I earned it, and if the CD was split, half in 2008 and half in 2009, I'll be paying the taxes for 2009 when I file (my) return. Please advise.
-- A.K. OK

a_v2.gifDear A.K.,
The typical grace period on a CD is seven to 10 days, so my reply isn't timely enough to help you with your rollover decision. But you bring up some points I'd like to address in the hope that it will help readers when moving IRA monies. It may also help you if you did take the interest as a distribution out of the IRA instead of rolling it over into another retirement account.

A rollover contribution from one IRA to another isn't the same as a trustee-to-trustee -- or "direct" -- transfer. But either way, neither method is subject to mandatory withholding. If the bank cut you a check, in almost all cases you have 60 days to deposit that money in a retirement account before the Internal Revenue Service considers it a distribution out of the account. After 60 days, the IRS may subject the money to income taxes and possibly a 10 percent penalty tax on an early distribution out of the account.

IRS Publication 590, Individual Retirement Arrangements, has additional details on this point in the section "Can You Move Retirement Plan Assets?"

If you did a trustee-to-trustee transfer of the funds to your employer's retirement plan, the bank shouldn't have cut you a check. It also should have known to transfer the whole amount.

Your ability to roll the money into your 401(k) account with your employer is limited by how the IRA account was initially funded. There's no issue if the IRA account was itself an IRA rollover account funded by monies from a previous employer's retirement plan. The IRA is considered a conduit IRA used as an interim place to hold the funds before rolling them into your new employer's 401(k) plan.

Additional funds contributed to the IRA can be transferred, too, if the employer's plan allows it. But there may be different tax implications. Here's what Form 590 says on the topic:

IRA as a holding account (conduit IRA) for rollovers to other eligible plans. If you receive an eligible rollover distribution from your employer's plan, you can roll over part or all of it into one or more conduit IRAs. You can later roll over those assets into a new employer's plan. You can use a traditional IRA as a conduit IRA. You can roll over part or all of the conduit IRA to a qualified plan, even if you make regular contributions to it or add funds from sources other than your employer's plan. However, if you make regular contributions to the conduit IRA or add funds from other sources, the qualified plan into which you move funds will not be eligible for any optional tax treatment for which it might have otherwise qualified.

Talk to your tax professional if you have commingled funds in your IRA account.

If you're not talking about much money, consolidating the IRA CD monies with the 401(k) account makes a lot of sense if the option is available to you. If the account is large enough to meet the size requirements of a mutual fund, explore the option of investing in a different IRA account. I say this because 401(k) plans often have limited investment choices, and you will have more flexibility in how the account is invested and the fees paid in the account by staying outside the employer's plan.

When the money is inside a traditional IRA account, you're not concerned about when the interest on the CD is paid. You're taxed on the distributions out of the account. The tax is due in the year the distribution is made, not when the interest was earned.

For more information on money in taxable accounts, read Bankrate Tax Adviser George Saenz's column "In which year is a CD's interest taxed?"

Read more Dr. Don columns for additional personal finance advice.

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