Stock investing for dummies – Understanding The IRA To 401k Reverse Rollover



Stock investing for dummies

stock-investing-for-dummies You likely know that, if you leave your employer, you should roll over your old 401k into a Rollover IRA (Individual Retirement Account). This strategy typically gives you more options for investment and flexibility with your money. But did you know that you can also do a reverse rollover? This is where you take your IRA money and roll it into your 401k account.

While it’s not very common, there are reasons why doing a reverse rollover from your IRA into your 401k could make sense. Let’s take a look at the major reasons why doing a reverse rollover might make sense in your situation, and the practical steps on how to do it.

Three Reasons To Do A Reverse Rollover

While there are likely more than three reasons to do a reverse rollover, these are the three most common reasons that a IRA to 401k reverse rollover might make sense.

The three reasons are:

  1. Preparing to do a mega backdoor Roth IRA conversion
  2. You’re still working at 70 1/2 and are facing required minimum distributions
  3. You’re thinking about retiring early and want penalty-free access to your money

Before we dive into the main reasons to do the reverse rollover, we want to remind you that every situation is different, and this might not make sense for your personal situation. Always consult a CPA about the taxability of these types of scenarios, because they can get complex.


Preparing For A Backdoor Roth IRA Conversion

If you’re considering doing a Backdoor Roth IRA Conversion, one of the first things you need to do is eliminate any money you have in a traditional, SIMPLE, or SEP IRA. The reason for this is that you can run into complexities and potential tax consequences if you have pre-tax money in any of these accounts when you convert.

As we previously discussed in our ultimate guide on how to do a mega backdoor Roth IRA conversion, one of the simplest ways to eliminate money in these pre-tax accounts is to roll it into an employer sponsored 401k. Remember, though, that you can only roll over pretax money into a 401k, so any non-deductible contributions you have made to these accounts don’t qualify.

Avoiding The 70 1/2 RMD Rule

If you’re 70 1/2 and have money in a traditional IRA, SEP IRA, or SIMPLE IRA, you’re required to take “Required Minimum Distributions” from your account. If you’re no longer working, and have a 401k, you’re also required to start taking required minimum distributions by April 1 of the year after you turn 70 1/2. However, there is an exception to this rule.

With a 401k, if you’re still working at the employer who sponsored your plan, you don’t have to take the RMD until after you retire. Employees who own more than 5 percent of the company sponsoring the plan can’t use this tactic and they must start distributions from their 401k accounts after age 70 1/2, regardless of whether they continue to work.

Since traditional and SEP IRAs require you to take an RMD at 70 1/2 regardless of whether you’re working, it can make sense to do a reverse rollover into your 401k if you want to delay taking the RMD.

Retiring Early And Getting Access To Your IRA Money

Believe it or not, a 401k is a little more flexible than an IRA when it comes to retiring early and getting access to your money without paying a penalty.

Typically, with both a 401k and IRA, if you want to access your money before age 59 1/2, you have to pay a 10% early withdrawal penalty on top of any taxes you’d normally pay. This can make it costly to access your money.

However, a 401k offers two ways that you can get access to your money if you retire early.

  1. The Rule Of 55 – If you retire at age 55, you can begin to withdraw money from your 401k without paying the penalty
  2. Section 72(t) Substantially Equal Periodic Payments – This is available to anyone, and you can setup equal payments based upon your life expectancy. Once the distributions begin, they must continue for a period of five years or until you reach age 59 1/2, whichever is longest. The full rules and life expectancy tables can be found in IRS Publication 590.

Both of these options don’t apply to money in an IRA, so this can be an attractive approach to be able to access your IRA money penalty free.

Warnings About Doing A Reverse Rollover

Before you jump into doing a reverse IRA to 401k Rollover, here are a few warnings that you need to consider.

First, only 69% of employer-sponsored 401ks currently allow reverse rollovers into them, according to the Plan Sponsor Council of America. So, before you go an cash out your IRA, make sure that your employer is willing and able to receive the deposit. Otherwise, you could be in for some trouble.

Second, make sure that you consult with your accountant or tax advisor. These types of distributions and transfers are complex. Not every accountant has seen them before, and it could raise red flags on your tax return. To protect yourself, you really should consult with an advisor who is knowledgeable in retirement plans and the taxability of these types of situations.

How To Do An IRA To 401k Reverse Rollover

On to the nitty-gritty. So you’ve decided that it makes sense for you to do an IRA to 401k reverse rollover. So, where do you actually begin? Here is our simple step-by-step guide on how to do the reverse rollover.

Step 1 – Confirm Eligibility

Before you begin anything, you need to confirm that your employer-sponsored 401k accepts IRA rollover funds. While doing this step, you should also get the deposit information from your 401k provider on where to send the check, what account numbers or information is needed, and what forms you might need to fill out (if any).

Step 2 – Request A Distribution

Once you’re 100% positive that your employer 401k accepts a rollover contribution from your IRA, you can request a distribution from your IRA. Each IRA provider has it’s own policies and procedures for doing a distribution, but you should be prepared to fill out a form and select the reason why you’re requesting the distribution.

At this step, make sure you select “Rollover”, otherwise your brokerage may attempt to withhold funds from your distribution for taxes. If your brokerage withholds funds from your distribution, you’ll need to come up with that money when you re-deposit it in your 401k.

Also, at this step is when you select where you want your check mailed, and who it should be mailed to. Some 401k providers will allow you to send the check directly to them for deposit. This is the easiest and cleanest approach. Just make sure that you have all of the required information needed from Step 1 (such as account numbers, etc).

Step 3 – Deposit The Funds In Your 401k

You have 60 days to re-deposit the money into your 401k, otherwise the IRS will consider it a distribution and you’ll be forced to pay that 10% penalty on the money. Also, if your brokerage withheld any funds from your distribution, you’ll need to deposit that amount as well, or that difference could be subject to the 10% penalty.

Really make sure you watch that timeline – it’s not about when you mail your check, it’s about when it’s deposited. So, not only could it take a few days in the mail, but it could also take a few days for your 401k provider to deposit the money into your account. The safest bet is to do everything the same day you receive your distribution check.

Step 4 – Report The Rollover Accurately On Your Tax Return

Finally, when you file your taxes, you need to report the rollover accurately, or you could face a 10% penalty and taxes on the distribution. All of the major online tax software companies make this step easy if you follow the directions.

You will receive a 1099-R from your IRA brokerage that shows the amount your withdrew from your IRA. On your 1040 tax return, you should report this amount as an IRA Distribution, however, the “Taxable Amount” of the distribution should be $0. You will then select “Rollover” as the reason why.

If the amount of your distribution from your IRA and the amount you deposited into your 401k don’t match, that difference is the “taxable amount” and you’ll owe taxes and a 10% penalty on that.

Should You Do A Reverse Rollover?

Now that you understand how an IRA to 401k reverse rollover works, and how to do it, should you consider it for your situation? Well, if you’re planning to do a backdoor Roth IRA conversion, or you’re looking to retire early, it could make a lot of sense to do it.

However, the process can be complicated, and over 30% of employer-sponsored 401k plans don’t even allow you to do it. However, the IRS has issued guidelines making the process more forgiving for 401k providers, and as such, more and more are allowing them.

The biggest takeaway here is to always check with your 401k provider before you start the process. You don’t want to go down this path only to realize you can’t do it.

Have you considered doing an IRA to 401k reverse rollover? If you’ve done it, what was your experience?

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