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Back to Basics: Moving Your Retirement Plan Money

Welcome back to Back to Basics!  In this edition, we will define some basic terms associated with moving funds into/out of/within a retirement plan.  

  • Distribution — Also known as a withdrawal, this is the primary method for receiving retirement plan assets as taxable income.  In order to receive a distribution from your retirement plan, you must be eligible for a distribution under the plan.  Distributions are  generally taxable unless rolled over (see below) and may be subject to a 10% premature distribution penalty if the recipient is under 59 ½ (termination of employment after age 55 is a major exception).  In addition, certain types of distributions are subject to an advance 20% withholding to pay for the taxes that are due at the time of tax filing.  The 20% withholding is NOT a tax, although it is often confused with the actual tax owed.  This withholding is similar to a payroll withholding, where the actual taxes owed at tax time may differ from the amount withheld.
  • Triggering Event — The provision in the plan document allowing a participant to take a distribution.  For example, this could be termination of employment, attainment of age 59 ½, occurrence of a financial hardship, etc.  A participant MUST experience a triggering event in order to be eligible for a distribution.
  • Rollover — A transaction in which a participant can avoid current taxation by re-depositing, or “rolling over” the distribution directly into a qualified retirement plan (401(a)/401(k)/403(b) or governmental 457(b)) or IRA.  There are two types of rollovers:  direct rollover, where funds are transferred directly to the new retirement plan/IRA provider; and indirect rollover, where funds are payable to the participant, but the participant has 60 days to redeposit the funds to a qualified retirement plan or IRA. The latter scenario is less common since 20% is required to be withheld from indirect rollovers, and the participant is required to make up the 20% withheld out of their own funds if they wish to roll over the entire distribution without incurring a taxable event.  It is important to remember that an individual must be eligible for a distribution (i.e., they must have a triggering event) in order to complete a rollover, since only eligible rollover distributions may be rolled over.  There are certain types of distributions, such as hardship distributions, that are not eligible rollover distributions.  Finally, rollovers from pre-tax accounts to Roth accounts are permitted, but taxes must be paid on the distribution, since future qualifying distributions on the Roth account are tax-free.
  • Plan-to-Plan Transfer — Often confused with rollovers, plan-to-plan transfers are an alternative to rollovers in moving funds between certain types of retirement plans.  Under this method, funds may be moved between 403(b) plans, between private tax-exempt 457(b) plans, and between 457(b) governmental plans.  Transfers to/from IRAs to qualified retirement plans and between other types of retirement plans (such as from a private tax-exempt 457(b) to a governmental 457(b)) are NOT permitted.  These transfers are not terribly common since participants who are eligible for them are often eligible for rollovers as well, and plan sponsors are less likely to permit plan-to-plan transfers.  However, for participants who are not eligible for a rollover, plan-to-plan transfers can be an option (e.g., private tax-exempt 457(b) plan participants are NOT permitted to roll over plan assets). Plan-to-plan transfers are NOT taxable events.
  • Exchange — An exchange is a transfer between recordkeepers within the same plan.  Exchanges are common in 403(b) plans, where it is not unusual for multiple recordkeepers to be present. An exchange does NOT require a triggering event, and is not a taxable event.  Plans may restrict exchanges between certain recordkeepers or prohibit exchanges entirely.
  • Conversion — This is a method of converting pre-tax amounts to Roth amounts within a retirement plan.   Participants incur taxes on the conversion amount, since future qualifying distributions are tax-free; however, the 10% premature distribution penalty does NOT apply, and there is no 20% withholding requirement.  Plans may prohibit conversions, or may require a triggering event in order to complete a conversion.

For more detailed information on rollovers, transfers and exchanges, please see our white paper on the subject. 

Editor’s Note: Back to Basics is a Top of Mind feature providing primers on retirement plan fundamentals for those new to the field and those who may need a little more background knowledge on retirement plan concepts (like you Finance and HR executives charged with a variety of tasks in addition to retirement plan administration!).  Earlier this year, the inaugural two-part edition of Back to Basics featured an explanation of some fundamental investment terms .

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Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

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