How to Roll Over an IRA Into a Qualified Plan
Though uncommon, there are several good reasons to do an IRA-to-plan rollover.
Question: Why would someone "roll" money from their IRA into their employer's qualified plan (e.g. a 401(k) plan)? And exactly how would they do that?
Answer: Though rollovers in that direction are not common, there are several reasons why someone would do such an "upstream" rollover.
For example, Andy has $500,000 in his IRA, of which $40,000 is after-tax money arising from his nondeductible contributions to the IRA over the years. He wants to roll the pretax money into his 401(k) plan so he can then, later, do a tax-free Roth conversion of the after-tax money left behind in the IRA.
Betty is concerned about potential creditors' claims. She has no debts now, and no plan to incur any, and carries good liability insurance, but still worries about getting sued for some uninsured claim. By moving money from her IRA to her employer's pension plan, she believes it will be safer from any potential lawsuit against her.
Carl works for an investment company which gets outstanding results for employees' money in the company 401(k) plan, but the company doesn't manage IRAs. By rolling his IRA into the company plan, Carl can access the superior investment performance offered by his employer.
Donna will turn 70 1/2 next year. She is still working for a university and has no plans to retire for at least five years. She will not have to take any required minimum distributions from the university's retirement plans until she retires, but she'll have to start taking RMDs from her IRA when she turns 70 1/2, regardless of how hard she's working. By rolling the IRA into her university retirement plan, she gives the IRA money the status of "qualified plan money"--and will have no RMDs until she retires.
The tax code does allow IRA money to be rolled into a qualified plan, subject to a few rules. One requirement (unique to IRA-to-plan rollovers) is that only pretax money can be rolled in that direction. A qualified plan cannot accept a rollover of after-tax money from an IRA.
Though the code section permitting IRA-to-plan rollovers has been around a long time, plans were hesitant to accept rollovers from IRAs because the plan administrator had no practical way to know he was getting only pretax money when he got a check from an employee's IRA. The IRS finally fixed that problem in 2014, issuing clear rules for how to do these rollovers.
Here are the steps you must follow to carry out an IRA-to-plan rollover.
Step 1: Consider getting professional assistance. Ideally your estate planning attorney, accountant, or financial planner should oversee the process to ensure that everything is done correctly. This also ensures that, if any mistakes are made, you will have some recourse. If you do the rollover on your own, you're on your own if mistakes are made--and the IRS isn't lenient on do-it-yourselfers.
Step 2: Verify that the qualified plan you want to roll money into accepts such rollovers. Plans are not obligated to accept every type of rollover, though their rules must not discriminate in favor of highly compensated employees. Get from the plan administrator the exact name that should be placed on the check so the plan can accept and deposit it.
Step 3: Determine the amount of pretax versus after-tax money you have in your IRAs. Remember that all your traditional IRAs are deemed to be a single account for this purpose, regardless of which IRA actually received any nondeductible contributions you made. In Andy's case, his pretax money total is $460,000. Therefore, the most he can roll into his employer's qualified plan is $460,000. He will ask the IRA provider to cut a check (make a distribution) from his IRA payable to "[Name of trustee of the employer's plan] for the benefit of [name of the employee]." The amount of the check can be anything up to the total of his pretax money ($460,000). The check should indicate on its face or on the attached stub that the source of the money is the employee's IRA. The IRA provider cuts the check as requested and gives it to the IRA owner to bring to the plan administrator.
Step 4: Withholding of 10% for federal income tax will apply to your IRA distribution. You must opt out of it if you don't want it--so keep a close eye on the forms you are signing in connection with your rollover. In some cases, the employee will want to proactively use income tax withholding from an IRA distribution as a way to make sure his income taxes get paid. In that case, he can allow the default 10% withholding to occur or request withholding from the distribution in a larger amount. Any amount so withheld for income taxes will be considered a taxable distribution for the year it occurs (not part of the tax-free rollover), to the extent it represents pretax money.
Step 5: Prepare and sign a statement certifying to the plan administrator of the employer plan that the check includes no after-tax amounts and that you will not have attained age 70 1/2 by the end of the year the check is issued (or, if you will have attained such age, that the RMD has previously been taken from the IRA). Deliver the check, the check stub (if applicable), and statement to the plan administrator.
Step 6: If you have rolled all of your traditional IRA money into the employer plan there is no Step 6--you're done. But if you have left the after-tax money in your IRA as Andy plans to do, your "Step 6" is to transfer what's left in the IRA (all or mainly after-tax money) into a Roth IRA. In Andy's case that would mean transferring about $40,000 into a Roth IRA, for a tax-free Roth conversion.
Step 7: Don't forget the follow up! Check all your account statements from the IRA and the plan to make sure they have charged and credited all payments correctly. Also, if you carried out the tax-free Roth conversion as Andy did, you must make sure that you do not make any further contributions to any traditional IRA in or for the calendar year in which the Roth conversion occurred. In determining whether an IRA-to-Roth-IRA conversion consists of pretax or after-tax money, the code doesn't just look at the IRA balance on the date you actually converted. Rather, it looks at your year-end traditional IRA balance for that year, adding back in to it any distributions and conversions that occurred during the year. So to get his tax-free Roth conversion, Andy needs his year-end traditional IRA balance to be zero.
Where to read more: See Rev. Rul. 2014-9, 2014-17 IRB 975, regarding the procedures for a direct rollover from a traditional IRA to a qualified plan. Otherwise, see Chapter 2 of Natalie Choate's book Life and Death Planning for Retirement Benefits (Ataxplan Publications; 7th ed. 2011), www.ataxplan.com, regarding rollovers. For rules on income tax withholding from retirement plan distributions, see 2.3 of Life and Death Planning for Retirement Benefits.
Natalie Choate will be speaking in San Diego (Oct. 27); Philadelphia (Nov. 14); Plymouth, Michigan (Dec. 7); Orlando, Florida (Jan. 25-26); Wilmington, Delaware (May 9); Bethlehem, Pennsylvania (May 10); and Waltham, Massachusetts (June 1). See all of Natalie's speaking events at www.ataxplan.com/seminars/schedule/
The author is a freelance contributor to Morningstar.com. The views expressed in this article may or may not reflect the views of Morningstar.