When funds are transferred directly from one IRA to another IRA What percentage of the tax is witheld?

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Employers of most pension plans are required to withhold a mandatory 20% of your lump sum retirement distribution when you leave their company. However, you can avoid this tax hit if you make a direct rollover of those funds to an IRA rollover account or another similar qualified plan. Failure to rollover the entire amount of your lump sum distribution may result in your paying unnecessary taxes on all or a portion of your retirement payout.

The 20% withheld from your lump sum retirement distribution is a federal income tax prepayment similar to the federal income taxes withheld from your pay check. It is held by the federal government as a credit toward you r tax liability for the year in which your payout was made. You can use that tax prepayment to reduce your tax liability when you file your tax return the following year, usually by April 15th. Or, if you over paid your federal taxes you will be entitled to a refund of the excess taxes withheld.

To avoid the tax hit completely on your lump sum retirement distribution, it is advisable that you contact your investment representative, banker or new employer's retirement administrator before you agree to receive your pension distribution. Establish a rollover IRA account with your investment broker or banker. My firm has established rollover accounts for several individuals. Next, instruct your pension administrator of the company that you are leaving or have left to transfer your lump sum distribution directly to your new IRA rollover account or qualified plan.

When your lump sum retirement distribution is transferred directly from one trustee to another trustee without your ever taking possession of any portion of those funds, you avoid that 20% tax withholding hit. With a direct rollover, your pension funds escape being taxed until some time in the future when you begin to withdraw from that rollover account.

Caution: should you receive a check and it is for only 80% of your retirement funds, you may wind up paying taxes if you do not take some immediate and decisive action.

How severe will that tax bite be if a entire rollover is not carried out? For any portion of your lump sum retirement distribution that is not rolled over within 60 days of receiving your retirement check, you can expect to pay taxes at your tax bracket rate. What's more, if you are under age 59 1/2 at the time you receive your retirement distribution, you will be hit with an additional tax penalty equal to 10% of any amount not rolled over within the required 60 day period. For someone truly concerned about reducing their tax bite and putting their pension funds to work prudently, a botched rollover can be costly.

For example, if you were due to receive a $100,000 lump sum distribution and your former employer withheld $20,000, you'd pay $7,600 (38% tax bracket) in taxes. If you are younger than 59 1/2, you'll be hit with an additional 10% tax penalty equal to $2,000. Your tax bill on your $20,000 will then be $9,600 versus "0" with a complete rollover.

How do you achieve a tax-free rollover when you received only 80% of your funds and you need to rollover 100% of the distribution? Well, the answer is, you must find the 20% withheld amount from some other source. In essence, the funds you rollover must equal 100% of the retirement funds paid out on your behalf. The source of that "missing" 20%, for rollover purposes, is not important so long as you place 100% of your lump sum retirement distribution amount in a rollover account within 60 days of your receiving your distribution check.

Of course, a direct rollover is the easiest method to avoid taxation on your entire lump sum retirement distribution. But, should you find yourself facing a tax bite on your funds because you are unable to rollover the entire distributed amount, try to reduce that tax bite as much as possible. At least rollover the 80% portion of your lump sum retirement distribution. Next, attempt to rollover some portion of the withheld 20%.

The key to a tax-free pension rollover is to keep your pension distribution intact in a rollover account until you reach age 59 1/2. Or, should you absolutely need to tap into your pension funds before then, do so sparingly and wisely.

Denise Lamaute, pension tax attorney and investment banker with Lamaute Capital, Inc. 8383 Wilshire Blvd. Suite 840 Beverly Hills, CA 213-655-1560, FAX: 213-655-8319

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Have you thought about rolling your traditional IRA from one financial institution to another? Maybe you're looking for higher returns, more investment selections, or better service. If you roll over your traditional IRA, there are some common mistakes you should avoid. In this article, we'll give you an overview of IRA rollover rules and discuss how to avoid common mistakes.

• If you leave a job or start a new one, you may need to roll over your retirement account to an IRA to preserve its tax-advantaged status.
• Rollovers must be completed within 60 days of receiving funds out of the old account, and only one rollover can occur per year.
• Direct transfers of retirement account funds to a new qualified account can be a more efficient method and can avoid breaking many of these rules by mistake.

“IRA rules can be tricky and some have even changed over the years, so you need to be careful, otherwise you could pay income tax and penalties,” says Dan Stewart, CFA®, president, Revere Asset Management Inc., in Dallas, Texas.

After you receive the funds from your IRA, you have 60 days to complete the rollover to another IRA. “That’s 60 days, not two months," says Marguerita M. Cheng, CFP®, CEO, Blue Ocean Global Wealth, Gaithersburg, MD. If you do not complete the rollover within the time allowed—or do not receive a waiver or extension of the 60-day period from the Internal Revenue Service (IRS)—the amount will be treated as ordinary income by the IRS.

That means you must include the amount as income on your tax return, and any taxable amounts will be taxed at your current, ordinary income tax rate. Plus, if you were not 59½ years old when the distribution occurred, you'll face a 10% penalty on the withdrawal.

You cannot make a second tax-free rollover of an IRA for one year after you distribute assets from your IRA and roll over any part of that amount. The downside to this is some banks may charge to issue a check to another bank or custodian when you are moving your IRA. 

This limit on IRA-to-IRA rollovers does not apply to eligible rollover distributions from an employer plan. Therefore, you can roll over more than one distribution from the same qualified plan, 403(b), or 457(b) account within a year. This one-year limit also does not apply to rollovers from traditional IRAs to Roth IRAs (i.e., Roth conversions).

You are allowed to make tax-free rollovers from your IRAs at any age, but if you are age 72 or older, you cannot roll over your annual required minimum distribution (RMD) because it would be considered an excess contribution.

If you are required to take an RMD each year, be sure to remove the current year’s RMD amount from your IRA before implementing the rollover.

Your rollover from one IRA to another IRA must consist of the same property. This means you cannot take cash distributions from your IRA, purchase other assets with the cash, then roll over those assets into a new (or the same) IRA. Should this occur, the IRS would consider the cash distribution from the IRA as ordinary income.

Here is a hypothetical example of how someone might violate the same property rule. An entrepreneur, aged 57, has decided to roll over her IRA from one financial institution to another. However, she wants to use her IRA assets to purchase shares of a certain company's stock. She takes a portion of the funds she received from her IRA, buys the shares, and places the remaining cash in a new IRA. Then, she deposits the shares of the stock she purchased into the same IRA to receive tax-deferred treatment.

The IRS would deem the portion of the distribution used to purchase the stock as ordinary income; therefore, the entrepreneur would owe taxes at her current, ordinary income tax rate on any taxable portion of the stocks that were rolled over. And, because she is younger than 59½, the IRS would assess a 10% penalty on any taxable portion of the amount used to purchase the stocks.

If you are simply moving your IRA from one financial institution to another and you do not need to use the funds, you should consider using the transfer method instead of a rollover. A transfer is non-reportable and can be done an unlimited number of times during any period. 

“A transfer removes the withdrawal process of the rollover, which ensures the assets go directly to their end account and investors remove the risk associated with the 60-day rule,” says Mark Hebner, founder and president of Index Fund Advisors, Inc., in Irvine, Calif., and author of The 12-Step Recovery Program for Active Investors.

“In my opinion, a direct transfer is the most optimal solution to move funds from one IRA to another,” says Carlos Dias Jr., founder and managing partner of Dias Wealth LLC in Lake Mary, Fla.

You can rollover funds from any of your own traditional IRAs, but you can also roll over funds to your traditional IRA from the following retirement plans:

If rollover eligible amounts from qualified plans, 403(b) plans, or governmental 457 plans are paid to you instead of processed as a direct rollover to an eligible retirement plan, the payer must withhold 20% of the amount distributed to you. Of course, you will receive credit for the taxes that were withheld. However, if you decide to roll over the total distribution, you will need to make up the 20%, out of pocket.

If you want to avoid the withholding and the associated reporting requirements, a direct rollover, sometimes referred to as a trustee-to-trustee transfer, is a method that should be used to effectuate your rollover from your qualified plan, 403(b) plan, or governmental 457 plan account. Plus, there is no 60-day window to worry about. Be sure to check with your plan administrator and IRA custodian regarding their documentation and operational requirements for processing a direct rollover on your behalf.

You might be able to move funds in the other direction, too. That is, you may be able to take a distribution from your IRA and roll it into a qualified plan. Your employer is not required to accept such rollovers, so check with your plan's administrator before you distribute the assets from your IRA. Certain amounts, such as nontaxable amounts and RMDs, cannot be rolled from an IRA to a qualified plan.