Demystifying IRA Rollovers and Stretch IRAs

Once you leave your job, whether due to a career change, retirement or termination, you will need to make one of the most important financial decisions in your life: what to do with your company-sponsored retirement plan assets. You have four basic options:

1. Stay invested in your current plan. In most circumstances, you can leave your money invested in your employer’s plan.
2. Receive a cash distribution. This may mean incurring withholding taxes of 20 percent, paying an additional 10 percent penalty if you take the distribution prior to age 59 ½, and negatively impacting your financial stability in retirement.
3. Move money to your new employer’s plan. If your new employer’s plan accepts retirement assets from previous plans, you may be able to roll over your existing retirement money to your new employer’s qualified retirement plan.
4. Roll over to a self-directed IRA. A rollover of your company-sponsored retirement plan assets directly to a self-directed IRA offers the advantages of continued tax deferral and a wider variety of investment options.

This article will address the option of rolling the assets into a self-directed IRA account and how you can use a planning technique called a “stretch IRA.”

An IRA rollover is permitted for any “eligible rollover distribution” from an employer-sponsored plan. There are two methods available to accomplish the IRA rollover—the direct rollover, or the indirect rollover.

Indirect rollover
In an indirect rollover, the employer-sponsored plan writes a distribution check to the employee, who deposits the check in his or her own account. The employee then has 60 days to transfer all or a portion of the amount received in the distribution to an IRA. In addition to the 60-day window to complete the rollover, there is a 20 percent mandatory withholding requirement. For example, if the employee requests a distribution of retirement assets valued at $100,000, the check payable to the employee will be $80,000, and a check in the amount of $20,000 will be sent to the IRS. To satisfy the 60-day rule for the entire distribution, the employee would need to add $20,000 of his/her own money to the $80,000 to complete the rollover. If you do not replace the amount withheld when completing the rollover, it will be considered a distribution subject to taxes and possible penalties. A refund for the tax withheld can be requested in the next tax year if the rollover was completed within 60 days.

Direct rollover
In a direct rollover, the eligible rollover distribution is transferred directly by the employer-sponsored plan to the employee’s IRA. The funds are never actually transferred to the employee individually. An important advantage of the direct rollover method is that the employee can avoid the IRS mandatory withholding rules and not be concerned with the 60-day window. Bottom line: Avoid the hassle and work with your employer to initiate a direct rollover.

If you decide to roll over your retirement plan assets to a self-directed IRA, you may want to use a planning technique referred to as a “stretch IRA.” “Stretching” an IRA refers to allowing IRA beneficiaries to reduce what they are required to withdraw from the account, thereby stretching out the length of time that the IRA assets will last. Through proper structuring of beneficiary designations, the value of the IRA can be enhanced over a number of years.

Always make sure you have the information you need to make good decisions about rollover options and whether a “stretch” IRA is right for you by seeking out the advice of your financial advisor, accountant or attorney. iBi