Individual retirement accounts offer tax perks that encourage you to squirrel away money for your later years. You can kick in some of your taxable income each year to a traditional or Roth IRA. In addition, employers can conjure up IRA-based retirement plans that can allow pretax contributions from you and the company. Two varieties are the simplified pension plan and the savings incentive match plan for employees of small employers. These plans have special rollover rules.
Eligible rollovers among qualified employers plans and traditional IRAs are generally tax-free. But Internal Revenue Service rules limit the rollover of certain withdrawals. For example, you can't roll over the money you siphon out of an employer plan because of financial hardship, required minimum distributions, substantially equal periodic payments, correction of excess contributions, loans, dividends on employer securities or the cost of any life insurance held in plans that allow life insurance -- this excludes IRAs.
You must complete the rollover within 60 days or arrange a direct trustee-to-trustee transfer. If you miss the deadline, the money will be included in your taxable income and you may also be hit with a 10 percent early withdrawal penalty. Unless you choose a direct transfer, employers withhold 20 percent of the funds for taxes.
Businesses with up to 100 workers can offer a SIMPLE IRA plan. As an employee, you can directly transfer money and property tax-free from one SIMPLE IRA plan to another at any time. However, you can't funnel a tax-free rollover from a SIMPLE IRA to any other type of retirement account during the first two years after the initial contribution to the SIMPLE account.
SIMPLE to non-SIMPLE rollovers made during the two-year period are taxable. You may also have to cough up the 10 percent penalty when you drain money out of a retirement plan before age 59 1/2. This penalty swells to 25 percent for SIMPLE to non-SIMPLE early distributions or rollovers during the first two years of your SIMPLE account.
Super SEP Rollovers
Simplified pension plans are available to any size business. These plans allow contributions only from employers, not from workers. The SEP contributions you receive immediately become your property, and your employer can't keep you from withdrawing or rolling over the money at any time. There is no two-year waiting period for SEP rollovers, which must follow the same rules that apply to traditional IRA rollovers. You can't roll a SEP-IRA into a SIMPLE IRA, although the rules allow rollovers in the opposite direction as long as you don't jump the two-year waiting period.
You can roll your SEP or SIMPLE money into a Roth IRA, but you will have to include the amount in your current taxable income. That's because you plow pretax dollars into a SEP or SIMPLE IRA and after-tax money into a Roth. The two-year rule for SIMPLE IRA withdrawals and rollovers also applies to rollovers into a Roth IRA.
Some employer plans offer designated Roth accounts that allow workers to kick in after-tax dollars. But you can't roll into a designated Roth account from a SEP or SIMPLE IRA. If you convert money from one of those accounts to a Roth IRA, you can change your mind by recharacterizing the rollover -- or undoing it -- before Uncle Sam takes his cut.
Based in Greenville SC, Eric Bank has been writing business-related articles since 1985. He holds an M.B.A. from New York University and an M.S. in finance from DePaul University. You can see samples of his work at ericbank.com.