Rollovers

If you withdraw cash or other assets from a qualified retirement plan in an eligible rollover distribution, you can defer tax on the distribution by rolling it over to another qualified retirement plan or a traditional IRA. You do not include the amount rolled over in your income until you receive it in a distribution from the recipient plan or IRA without rolling over that distribution. (For information about rollovers from traditional IRAs, see chapter 1 of Publication 590.)

If you roll over the distribution to a traditional IRA, you cannot deduct the amount rolled over as an IRA contribution. When you later withdraw it from the IRA, you cannot use the optional methods discussed earlier under Lump-Sum Distributions to figure the tax.

Self-employed individuals are generally treated as employees for the rules on the tax treatment of distributions, including the rules for rollovers.

Qualified retirement plan.   For this purpose, the following plans are qualified retirement plans.

• A qualified employee plan.
• A qualified employee annuity.
• A tax-sheltered annuity plan (403(b) plan).
• An eligible state or local government section 457 deferred compensation plan.

Eligible rollover distribution.   An eligible rollover distribution is any distribution of all or any part of the balance to your credit in a qualified retirement plan except:

1. Any of a series of substantially equal distributions paid at least once a year over:
   1. Your lifetime or life expectancy,
   2. The joint lives or life expectancies of you and your beneficiary, or
   3. A period of 10 years or more,
2. A required minimum distribution (discussed later under Tax on Excess Accumulation),
3. Hardship distributions,
4. Corrective distributions of excess contributions or excess deferrals, and any income allocable to the excess, or of excess annual additions and any allocable gains (see Corrective distributions of excess plan contributions, at the beginning of Taxation of Nonperiodic Payments, earlier),
5. A loan treated as a distribution because it does not satisfy certain requirements either when made or later (such as upon default), unless the participant's accrued benefits are reduced (offset) to repay the loan (see Loans Treated as Distributions, earlier),
6. Dividends on employer securities, and
7. The cost of life insurance coverage.

In addition, a distribution to the plan participant's beneficiary generally is not treated as an eligible rollover distribution. However, see Qualified domestic relations order and Rollover by surviving spouse, later.

Rollover of nontaxable amounts.   You may be able to roll over the nontaxable part of a distribution (such as your after-tax contributions) made to another qualified retirement plan or traditional IRA. The transfer must be made either through a direct rollover to a qualified plan that separately accounts for the taxable and nontaxable parts of the rollover or through a rollover to a traditional IRA.

If you roll over only part of a distribution that includes both taxable and nontaxable amounts, the amount you roll over is treated as coming first from the taxable part of the distribution.

Withholding requirements.   If an eligible rollover distribution is paid to you, the payer must withhold 20% of it. This applies even if you plan to roll over the distribution to another qualified retirement plan or to an IRA. However, you can avoid withholding by choosing the direct rollover option, discussed later. Also, see Choosing the right option at the end of this discussion.

Exceptions.   An eligible rollover distribution is not subject to withholding to the extent it consists of net unrealized appreciation from employer securities that can be excluded from your gross income. (For a discussion of the tax treatment of a distribution of employer securities, see Figuring the Taxable Amount under Taxation of Nonperiodic Payments, earlier.)

In addition, withholding from an eligible rollover distribution paid to you is not required if:

• The distribution and all previous eligible rollover distributions you received during the tax year from the same plan (or, at the payer's option, from all your employer's plans) total less than $200, or
• The distribution consists solely of employer securities, plus cash of $200 or less in lieu of fractional shares.

Direct rollover option.   You can choose to have any part or all of an eligible rollover distribution paid directly to another qualified retirement plan that accepts rollover distributions or to a traditional IRA.

No tax withheld.   If you choose the direct rollover option, no tax will be withheld from any part of the distribution that is directly paid to the trustee of the other plan. If any part of the eligible rollover distribution is paid to you, the payer must generally withhold 20% of it for income tax.

Payment to you option.   If an eligible rollover distribution is paid to you, 20% generally will be withheld for income tax. However, the full amount is treated as distributed to you even though you actually receive only 80%. You generally must include in income any part (including the part withheld) that you do not roll over within 60 days to another qualified retirement plan or to a traditional IRA.

If you are under age 59½ when a distribution is paid to you, you may have to pay a 10% tax (in addition to the regular income tax) on the taxable part (including any tax withheld) that you do not roll over. See Tax on Early Distributions, later.

Partial rollovers.   If you receive a lump-sum distribution, it may qualify for special tax treatment. See Lump-Sum Distributions, earlier. However, if you roll over any part of the distribution, the part you keep does not qualify for special tax treatment.

Rolling over more than amount received. If the part of the distribution you want to roll over exceeds (due to the tax withholding) the amount you actually received, you will have to get funds from some other source (such as your savings or borrowed amounts) to add to the amount you actually received.

Example.   You receive an eligible rollover distribution of $10,000 from your employer's qualified employee plan. The payer withholds $2,000, so you actually receive $8,000. If you want to roll over the entire $10,000 to postpone including that amount in your income, you will have to get $2,000 from some other source to add to the $8,000 you actually received.

If you roll over only $8,000, you must include the $2,000 not rolled over in your income for the distribution year. Also, you may be subject to the 10% additional tax on the $2,000 if it was distributed to you before you reached age 59½.

Time for making rollover.   You generally must complete the rollover of an eligible rollover distribution paid to you by the 60th day following the day on which you receive the distribution from your employer's plan.

The IRS may waive the 60-day requirement where the failure to do so would be against equity or good conscience, such as in the event of a casualty, disaster, or other event beyond your reasonable control.

Example.   In the previous example, you received the distribution on June 30, 2003. To postpone including it in your income, you must complete the rollover by August 29, 2003, the 60th day following June 30.

Frozen deposits.   If an amount distributed to you becomes a frozen deposit in a financial institution during the 60-day period after you receive it, the rollover period is extended. An amount is a frozen deposit if you cannot withdraw it because of either:

• The bankruptcy or insolvency of the financial institution, or
• A restriction on withdrawals by the state in which the institution is located because of the bankruptcy or insolvency (or threat of it) of one or more financial institutions in the state.

The 60-day rollover period is extended by the period for which the amount is a frozen deposit and does not end earlier than 10 days after the amount is no longer a frozen deposit.

Retirement bonds.   If you redeem retirement bonds purchased under a qualified bond purchase plan, you can roll over the proceeds that exceed your basis tax free into an IRA or qualified employer plan. Subsequent distributions of those proceeds, however, do not qualify for the 10-year tax option or capital gain treatment.

Annuity contracts.   If an annuity contract was distributed to you by a qualified retirement plan, you can roll over an amount paid under the contract that is otherwise an eligible rollover distribution. For example, you can roll over a single sum payment you receive upon surrender of the contract to the extent it is taxable and is not a required minimum distribution.

Rollovers of property.   To roll over an eligible rollover distribution of property, you must either roll over the actual property distributed or sell it and roll over the proceeds. You cannot keep the distributed property and roll over cash or other property.

If you sell the distributed property and roll over all the proceeds, no gain or loss is recognized on the sale. The sale proceeds (including any portion representing an increase in value) are treated as part of the distribution and are not included in your gross income.

If you roll over only part of the proceeds, you are taxed on the part you keep. You must allocate the proceeds you keep between the part representing ordinary income from the distribution (its value upon distribution) and the part representing gain or loss from the sale (its change in value from its distribution to its sale).

Example 1.   On September 6, 2002, Paul received an eligible rollover distribution from his employer's noncontributory qualified employee plan of $50,000 in nonemployer stock. On September 27, 2002, he sold the stock for $60,000. On October 4, 2002, he contributed $60,000 cash to a traditional IRA. Paul does not include either the $50,000 eligible rollover distribution or the $10,000 gain from the sale of the stock in his income. The entire $60,000 rolled over will be ordinary income when he withdraws it from his IRA.

Example 2.   The facts are the same as in Example 1, except that Paul sold the stock for $40,000 and contributed $40,000 to the IRA. Paul does not include the $50,000 eligible rollover distribution in his income and does not deduct the $10,000 loss from the sale of the stock. The $40,000 rolled over will be ordinary income when he withdraws it from his IRA.

Example 3.   The facts are the same as in Example 1, except that Paul rolled over only $45,000 of the $60,000 proceeds from the sale of the stock. The $15,000 proceeds he did not roll over includes part of the gain from the stock sale. Paul reports $2,500 ($10,000/$60,000 × $15,000) as capital gain and $12,500 ($50,000/$60,000 × $15,000) as ordinary income.

Example 4.   The facts are the same as in Example 2, except that Paul rolled over only $25,000 of the $40,000 proceeds from the sale of the stock. The $15,000 proceeds he did not roll over includes part of the loss from the stock sale. Paul reports $3,750 ($10,000/$40,000 × $15,000) capital loss and $18,750 ($50,000/$40,000 × $15,000) ordinary income.

Property and cash distributed.   If both cash and property were distributed and you did not roll over the entire distribution, you may designate what part of the rollover is allocable to the cash distribution and what part is allocable to the proceeds from the sale of the distributed property. If the distribution included an amount that is not taxable (other than the net unrealized appreciation in employer securities) as well as an eligible rollover distribution, you may also designate what part of the nontaxable amount is allocable to the cash distribution and what part is allocable to the property. Your designation must be made by the due date for filing your tax return, including extensions. You cannot change your designation after that date. If you do not make a designation on time, the rollover amount or the nontaxable amount must be allocated on a ratable basis.

Qualified domestic relations order (QDRO).   You may be able to roll over tax free all or part of a distribution from a qualified retirement plan that you receive under a QDRO. (See Qualified domestic relations order (QDRO) under General Information, earlier.) If you receive the distribution as an employee's spouse or former spouse (not as a nonspousal beneficiary), the rollover rules apply to you as if you were the employee.

Rollover by surviving spouse.   You may be able to roll over tax free all or part of a distribution from a qualified retirement plan you receive as the surviving spouse of a deceased employee. The rollover rules apply to you as if you were the employee. You can roll over the distribution into a qualified retirement plan or a traditional IRA.

A distribution paid to a beneficiary other than the employee's surviving spouse is not an eligible rollover distribution.

How to report.   Enter the total distribution (before income tax or other deductions were withheld) on line 16a of Form 1040 or line 12a of Form 1040A. This amount should be shown in box 1 of Form 1099-R. From this amount, subtract any contributions (usually shown in box 5 of Form 1099-R) that were taxable to you when made. From that result, subtract the amount that was rolled over either directly or within 60 days of receiving the distribution. Enter the remaining amount, even if zero, on line 16b of Form 1040 or line 12b of Form 1040A. Also, write "Rollover" next to line 16b on Form 1040 or line 12b of Form 1040A.

Written explanation to recipients.   The administrator of a qualified retirement plan must, within a reasonable period of time before making an eligible rollover distribution, provide you with a written explanation. It must tell you about all of the following.

• Your right to have the distribution paid tax free directly to another qualified retirement plan or to a traditional IRA.
• The requirement to withhold tax from the distribution if it is not directly rolled over.
• The nontaxability of any part of the distribution that you roll over within 60 days after you receive the distribution.
• Other qualified retirement plan rules that apply, including those for lump-sum distributions, alternate payees, and cash or deferred arrangements.
• How the distribution rules of the plan to which you roll over the distribution may differ from the rules that apply to the plan making the distribution in their restrictions and tax consequences.

Reasonable period of time.   The plan administrator must provide you with a written explanation no earlier than 90 days and no later than 30 days before the distribution is made. However, you can choose to have a distribution made less than 30 days after the explanation is provided as long as the following two requirements are met.

• You must have the opportunity to consider whether or not you want to make a direct rollover for at least 30 days after the explanation is provided.
• The information you receive must clearly state that you have the right to have 30 days to make a decision.

Contact the plan administrator if you have any questions regarding this information.

Choosing the right option.   Table 1 may help you decide which distribution option to choose. Carefully compare the effects of each option.

Table 1. Comparison of Payment to You Versus Direct Rollover

Affected item	Result of a payment to you	Result of a direct rollover
Withholding	The payer must withhold 20% of the taxable part.	There is no withholding.
Additional tax	If you are under age 59½, a 10% additional tax may apply to the taxable part (including an amount equal to the tax withheld) that is not rolled over.	There is no 10% additional tax. See Tax on Early Distributions, later.
When to report as income	Any taxable part (including the taxable part of any amount withheld) not rolled over is income to you in the year paid.	Any taxable part is not income to you until later distributed to you from the new plan or IRA.

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