You’ve opened and contributed to a traditional IRA, invested it, waited several months, and you’re now ready to exercise the option to convert it into a Roth IRA. Now, because you’ve read the blog on how to do a backdoor Roth IRA correctly, you also know that before you do that Roth conversion, you need to move any pre-tax IRAs out of the IRA into a 401(k) or similar plan. This includes IRAs like a SEP IRA or a rollover IRA. While a reverse rollover may not be common, there are times a IRA to 401(k) rollover makes sense. In this blog, we will explain the reasons for and against an IRA to a 401(k) rollover and how you can do it.
What is a reverse rollover?
A rollover is tax terminology for moving money from one retirement account to another. The most common rollover is rolling a 401(k) to an IRA. Rollovers usually happen when you leave your job and can no longer participate in the company’s plan. Moving money the other way, from an IRA to a 401(k) is known as a reverse rollover.
Reasons to do a IRA to a 401(k) rollover
- You are preparing to do a backdoor Roth IRA conversion: if you are thinking of doing a backdoor Roth IRA then one of the first things that you need to do is eliminate any money you have in a traditional, SIMPLE, or SEP IRA. If you don’t then you could end up with a surprise tax bill due to the IRS Pro-rata rule when it comes to Roth conversions. One of the easiest ways to do this is to roll it into a 401(k) if you have a 401(k) that will accept IRA rollover contributions.
- You prefer convenience over control.
- You want to delay required minimum distributions: The IRS has a mandatory requirement that you begin taking distributions by April 1 of the year following your 72nd birthday. However, you can delay taking distributions from your 401(k) if you are still working.
- You want to access your money earlier: You cannot usually withdraw your IRA until 59 ½ without triggering the government’s 10% early distribution penalty. Money from your 401(k) may be eligible for withdrawal at the age of 55 under certain circumstances.
- Stronger legal protection: federal law protects all of your 401(k) assets in the event of certain legal troubles.
- Streamlining your accounts: some people like having all of their retirement money in one place to keep it simple.
Reasons to not do an IRA to 401(k) rollover
- Less control: With an IRA you have full control of your assets. With a 401(k), your employer controls some aspects, such as where the money is and which investments are available to you.
- Fees may be higher: You are stuck with the fee schedule for a 401(k). This can sometimes eat into your retirement savings. For an IRA, you can shop around for the plan with the lowest fees.
How do I complete an IRA to 401(k) rollover?
Step 1: Check eligibility
The first step is to check whether your employer’s 401(k) plan accepts IRA rollovers. Every organization is different and you may not be able to do an IRA to 401(k) rollover. If they do allow it, then you will want to make sure that you do a direct transfer, if available, to make sure that you don’t incur the 10% penalty.
Step 2: Request distribution
The next step is to request a distribution from your IRA. There will be some paperwork to fill out. Generally, “Direct rollover” is what you enter as the reason for distribution. They will then send an electronic transfer to the 401(k) trustee. This ensures that you never receive the money personally so you won’t be liable for any taxes. This transaction is tax-free and penalty-free.
Make sure you report the rollover on your tax return
You must report direct and indirect rollovers on your annual tax return. You will receive a 1099-R from your IRA brokerage. This will have the amount that you withdraw on it. Report that number on your 1040 tax return on the line labeled “IRA distributions”. If the amount on your IRA withdrawal and the amount you deposited into your 401(k) don’t match then you may be subject to a 10% tax penalty on that difference.
If you have multiple retirement accounts, you can often move money between them without consequences. The most common move is to roll your 401(k) to an IRA, but it is possible to roll a pretax IRA to a 401(k). The biggest piece of advice is to check with your 401(k) provider to see if they will let you do an IRA to 401(k) rollover before starting the process. The different rules that apply to 401(k) and IRA accounts can be confusing. When considering a rollover of any kind, it’s best to work with a CERTIFIED FINANCIAL PLANNER® to make sure you are on the right track.
Alvin Carlos, CFP®, CFA is an investment advisor and fee-only financial planner, in Washington, D.C that works with clients across the country. He has a Master’s degree in International Relations from SAIS-Johns Hopkins. Alvin is a partner of District Capital, a financial planning firm designed to help professionals in their 30s and 40s achieve their financial goals through smart investing, reducing taxes, retirement planning, and maximizing their money. Schedule a free discovery call to learn how we can help elevate your finances.