When the Reverse Makes Sense: Benefits of a Reverse Rollover | Lord Abbett
Image alt tag

Error!

There was a problem contacting the server. Please try after sometime.

Sorry, we are unable to process your request.

Error!

We're sorry, but the Insights and Intelligence Tool is temporarily unavailable

If this problem persists, or if you need immediate assistance, please contact Customer Service at 1-888-522-2388.

Error!

We're sorry, but the Literature Center checkout function is temporarily unavailable.

If this problem persists, or if you need immediate assistance, please contact Customer Service at 1-888-522-2388.

Tracked Funds

You have 0 funds on your mutual fund watch list.

Begin by selecting funds to create a personalized watch list.

(as of 12/05/2015)

Pending Orders

You have 0 items in your cart.

Subscribe and order forms, fact sheets, presentations, and other documents that can help advisers grow their business.

Reset Your Password

Financial Professionals*

Your password must be a minimum of characters.

Confirmation Message

Your LordAbbett.com password was successully updated. This page will be refreshed after 3 seconds.

OK

 

Retirement Perspectives

Though less common, there are times when a reverse rollover may make sense.

Read time: 4 minutes

A rollover is a tax-deferred movement of 401(k) funds into an Individual Retirement Account (IRA). But retirement-account rollovers are a two-way street. In certain situations, investors may want to consider rolling assets from a traditional IRA into an employer-sponsored retirement plan—otherwise known as a “reverse rollover.”

 

Most people know you can roll over a 401(k)or a 403(b) into an IRA, but few know that a “reverse rollover” is an available option. There are pros and cons to this scenario.

 

When it comes to reverse rollovers, certain questions usually come up. “I didn’t know you can roll an IRA into a 401(k)! Is this something new?” “Why would I want to do a reverse rollover?” “Is a reverse rollover subject to taxation?” Good questions!

401(k) plans are required to allow participants’ assets to roll out of the plan into an IRA, but surprisingly, there is no corresponding rule that states plans must allow for rollovers into the plan. So first, we encourage you to check with your employer to determine if your plan allows for a reverse rollover.

Reasons to consider a reverse rollover

For some individuals, moving funds from an IRA to a 401(k) plan has advantages.

  • Delays Required Minimum Distributions – Are you age 72 or older, actively employed, and don’t need the income from your IRA that’s generated through required minimum distributions (RMDs)? If you’re working past age 72, RMDs are generally not required from 401(k)s—until the year you retire. This rule is called the “still-working exception” and is available only if you do not own more than 5% of the company sponsoring the plan, and the plan offers it. In other words, the still-working exception is discretionary. We suggest checking with your employer to see if it’s a plan option.

Here, a reverse rollover could pay dividends because you aren’t forced to take RMDs from your 401(k) account (even if you are over age 72) until after you’ve separated from service or retired. IRA RMDs, on the other hand, (including SEPs and SIMPLEs) commence in the year you turn 72, regardless of whether you’re employed.

EXAMPLE: Tim, using the still-working exception, did a reverse rollover to his 401(k) when he was age 71, knowing he wasn’t going to retire soon. Later Tim, now 83, retires in 2021. The reverse rollover deferred more than a decade of RMDs that he would otherwise have been forced to take from his IRA!

  • IRA Basis - Do you have a traditional IRA that contains after-tax dollars (basis)? Usually, when  any traditional IRA you own (including SEP and SIMPLE accounts) contains both pre-tax (tax-deductible contribution plus earnings) and after-tax money, a withdrawal (e.g., rollover, Roth conversion, RMD, normal distribution etc.) is partially taxable (referred to as the IRS “pro-rata” rule), and the calculation and tax report is onerous. Learn more here.

You’re not permitted to do a reverse rollover of after-tax (non-deductible) IRA funds. Instead, only pre-tax IRA funds qualify for reverse rollover treatment. This rule at first glance may seem unfavorable. In reality, it offers the ability to “split” IRA pre-tax and after-tax dollars, which in turn offers a potential tax-free Roth conversion!

EXAMPLE: Ben has a $100,00 traditional IRA of which $30,000 consists of basis (after-tax funds), and the remaining $70,000 is pre-tax. Since a 401(k) can only accept pre-tax funds, the basis can’t be rolled over and must remain in his IRA. After Ben rolls over the $70,000 to his 401(k), what’s left in his IRA ($30,000) is all after-tax dollars, which can now be converted to a Roth IRA, free of taxes. Why? Because taxes had previously been paid on these funds, there is no tax bill for the Roth conversion.

PRACTICE TIP: Roth IRA funds cannot be rolled over into a 401(k) or any other qualified, employer- sponsored retirement plan.

  • Rule of 55 – Did you separate from your employer in the year you reached age 55 or later? If so, you are eligible to take a distribution without paying the 10% early distribution penalty tax. This option does not extend to IRAs. With a traditional IRA, you generally must wait until age 59 ½ to withdraw funds without penalty.
  • Access to Loans – A 401(k) plan can (but is not required to) offer a plan loan. An IRA does not offer loans.
  • Creditor Protection – 401(k) assets are protected from creditors whereas IRA protection (if any) is based on state law.  

There are situations where a reverse rollover may not be advisable, including:

  • Greater Choice of Investments – An IRA allows you to invest in almost anything (with limited exceptions such as life insurance and collectibles). A 401(k) plan offers you a set “menu” of pre-selected investments.
  • 10% Penalty-Tax Exceptions – There are several exceptions to the 10% early distribution penalty tax for withdrawals before attaining age 59 ½. However, a number of the exceptions only apply to IRA withdrawals (e.g., first-time home purchase or higher-education expenses). In other words, doing a reverse rollover would exclude you from these exceptions as 401(k) distributions do not qualify
  • Flexibility You can take a distribution, generally subject to taxes and/or penalty, from your IRA at any time, for any reason at any age. A distribution from a 401(k) can be taken only a after a stated event (i.e., separation from service, disability, financial hardship, etc.).

Key Takeaways:

  • A regular rollover is when you roll 401(k) or 403(b) money into an IRA. Less well known is a “reverse rollover,” which is just the opposite—rolling IRA money into a 401(k) plan.
  • Not every retirement plan permits a reverse rollover; check with your employer or plan administrator.
  • Individuals interested in a reverse rollover should understand all the ramifications before pursuing this strategy. It is prudent to consult a tax advisor.

These materials do not take into account individual client circumstances, objectives, or needs. No determination has been made regarding the suitability of any securities, financial instruments, or strategies for particular clients or prospects. These materials do not purport to provide any legal, tax, or accounting advice. The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

 

RELATED TOPICS

ABOUT THE AUTHOR

image

Please confirm your literature shipping address

Please review the address information below and make any necessary changes.

All literature orders will be shipped to the address that you enter below. This information can be edited at any time.

Current Literature Shipping Address

* Required field