Retirement Plans: Conversion, Taxation and Rollover Rules

Retirement Plans - Now Often Half of Assets 

Retirement plans now comprise over half of assets owned by individuals and as part of their estate plan.  Income tax of up to 35% is due on all withdrawals by beneficiaries at their own marginal rate.    Wills do not usually change beneficiary designations.  If you are an employee, you contact the plan custodian to name your beneficiaries.  See beneficiary designation options.   

What is a Qualified 401(k) Plan? - Employer Rules 

Where a company has 100 or more employees, the company must enroll the majority of the staff and cannot have over 60% of plan assets held by highest paid staff under the "top heavy rules".   The Plan cannot be managed to benefit highly compensated staff under the nondiscrimination rules.  

Pre-Tax IRAs 

Rollover IRA contains money from an employer 401K) plan transferred directly into new financial institution.  Traditional IRA allows pre tax deductible payment into an account for individuals not eligible to joint employer 401(k) plan.  Employee in a 401(k) plan can contribute to the IRA after tax.  And, the lesser earning spouse can make pre-tax contribution to spousal IRA. 

What is a Qualified 401(k) Plan?  Employee Benefits 

This type of plan is also called a defined contribution plan.  Employee's contributions will reduce adjusted gross income dollars per dollar not just itemized deduction.  The employer matches pre-tax contributions.  Employee contribution can be a percentage of salary based on age. 

401(k) advantages to Employee and Employer 

Protection of accounts from creditors under the Federal Employee Retirement Income Security Act of 1974.  Accounts are not includible in a bankruptcy estate.  Employee must be an active participant and still employed at the managing company.  Employee can take out a loan from the plan to be repaid from salary over five years.  

Transfer of 401(k) plans between employers 

Employee must establish a new account at new employer.  Employee must contact old employer to transfer funds to from custodian to custodian and that type of transfer is not a taxable event.  If the employee receives the funds in her own name, the employee can transfer into new employer's fund within 60 days of separation from employment but that type of transfer is usually a partially taxable event. 

Employee Duties on 401(k) Transfer 

Employee must repay any loans from the plan at separation.  The employee can wait until end of the calendar year to restore loan funds to  new employer account.  If employee failed to transfer custodian to custodian, employee must restore loan funds to new employer account.  If there is nos repayment by employee of loan and tax, those items will be taxable to the transferring employee. 

Converting 401(k) to Rollover 

Establish a new rollover account at a financial institution, which usually cannot be commingled with prior rollover funds.  Then instruct the plan custodian to transfer the funds directly to the financial institution's rollover custodian.  This transfer is not a taxable event.  Under the Bankruptcy Reform Act of 2005, the first $1,500,000 of a new account is exempt from bankruptcy claims. 

Roth Principles

The Roth was created in 1997 when high taxes were paid on pre-tax IRAs and 401(k) payouts.  You can contribution after tax money with no reduction in adjusted gross income and no itemized deduction.  Distributions made after the owner is 59 1/2 with funds in plan over 5 years are not subject to any income tax on contribution or growth. 

"Traditional" Roth IRAs 

Individuals with lower income can contribute the same range annually and the contributions are after tax dollars that do not reduced adjusted gross income.  Distributions made after the owner is 59 1/2 with funds in plan over 5 years are not subject to any income tax. 

Employer-Sponsored Roth 401(k) 

There is no limit on employee income or household income to contribute and distributions made after the owner is 59 1/2 with funds in the plan over 5 years are subject to income tax.  Total employee contributions have limits.  This plan can rollover directly to Roth IRA with tax payment. 

Converting pre-tax 401(k) to Roth Rollover 

Here, the employee establishes a new Roth account at a financial institution.  The custodian of the former qualified pre-tax employer 401(k) transfers funds directly to custodian of the new Roth account.  Employee must pay income tax at current rate on entire transfer during the tax year of the transfer.  On this type of conversion you must wait 5 years to make a completely tax free withdrawal, even if over 59 1/2 years old. 

Inherited IRAs 

Most beneficiaries must liquidate and pay taxes within ten years of inheritance under the SECURE Act.  Eligible beneficiaries can take longer--which include the spouse, minor child or individual within 10 years of age of deceased and the disabled or chronically ill.  Secure Act

If you would like to consult regarding integrating your accounts in to your estate plan, please call The Law Offices of Gayla K. Austin at 307.200.1914.