Can 401 Disbursement in December Be Rolled Over in January

Executive Summary

For many individuals, their 401(k) makes up the bulk of their retirement savings, yet with an average of just over 10 job changes through one's career, it's not uncommon for people to have multiple (potentially expensive and restrictive) employer-sponsored retirement plans. Which means that transferring money out of various retirement plans into an IRA can be tremendously beneficial on many fronts, including lower costs and complexity, as well as increased investment options.

As we approach the end of the year, a common question on clients' minds is whether or not they should consider rolling over money from their retirement plan into an IRA, and in this week's #OfficeHours with @MichaelKitces, my weekly broadcast via Periscope and guest hosted this week by Jeff Levine, we discuss the benefits such a move, some of the potential pitfalls you might encounter along the way, and a few rules to keep in mind when making a rollover near the end of the year.

In order to understand the available options, it's important to first understand the reasons for not rolling money between retirement accounts in the first place. For instance, clients who completed a Roth conversion earlier in the year that included after-tax dollars but still have pre-tax dollars in the traditional IRA would see their year-end balances impacted, making their prior conversion a lot less tax-efficient. Meanwhile, if a client wants to preserve and utilize a "still working" exception in order to delay RMDs from their employer-sponsored plans, then that option will be lost when rolling money into an IRA.

With that in mind, what are some good reasons to complete a rollover into the end of the year? First and foremost is convenience and ease. Because consolidating retirement accounts can reduce the complexity of keeping track of multiple accounts. This is particularly pertinent for individuals over 70 ½ who are subject to RMDs, since it doesn't matter which IRA their RMDs are taken from as long as the total (and correct amount) is distributed, whereas RMDs must be taken from each employer-sponsored retirement plan account.

Meanwhile, clients who are interested in a making a qualified charitable distribution (where individuals can reduce their taxable income by using their RMD to contribute money to a charity), that QCD can only come from an IRA. Which, in turn, is based on the year-end balance in that IRA, meaning that there has to be money in the IRA in the first place! In a similar vein, clients who might want to purchase a qualified longevity annuity contract may not have that as an option in their employer-sponsored retirement accounts. Instead, a QLAC is more commonly purchased inside an IRA, but again, is subject to certain limitations that can be addressed by completing a year-end rollover.

Additionally, for clients over 70 ½ with a spouse that is at least 10 years their junior, rolling money into an IRA or other retirement account where that spouse is the sole beneficiary before year-end will lower the RMD from that IRA in the following year. And finally, rolling money from a 401(k) into a Roth IRA can be an effective means of reducing RMDs in the future, and is especially attractive at this time due to the lower tax rates (temporarily?) in effect following the passage of the Tax Cuts and Jobs Act.

Although there are some rules to keep in mind when taking advantage of these year-end planning opportunities at the end of the year, they aren't terribly complex. Specifically, any money that leaves one account must be out before December 31st, but beyond the common timeframes for rollovers, it's okay if the money doesn't transfer into the receiving account until after January 1st. One thing that's important to keep in mind for clients subject to RMDs, however, is that the custodian likely will not track that last minute change, and it will be up to the advisor to make sure to account for any year-end balance increases for the following year's RMD.

Ultimately, the key point is to avoid completing any sort of rollover if it is not tax-efficient, but there are some good reasons to move money between tax-favored retirement accounts, particularly towards the end of the year, as well as opportunities for advisors to add value for their clients by helping them manage their tax exposure, particularly for those clients fortunate enough to not rely on distributions from their retirement account for income in retirement!

Jeff Levine Headshot Photo

Jeffrey Levine, CPA/PFS, CFP, AIF, CWS, MSA is the Lead Financial Planning Nerd for Kitces.com, a leading online resource for financial planning professionals, and also serves as the Chief Planning Officer for Buckingham Wealth Partners. In 2020, Jeffrey was named to Investment Advisor Magazine's IA25, as one of the top 25 voices to turn to during uncertain times. Also in 2020, Jeffrey was named by Financial Advisor Magazine as a Young Advisor to Watch. Jeffrey is a recipient of the Standing Ovation award, presented by the AICPA Financial Planning Division for "exemplary professional achievement in personal financial planning services." He was also named to the 2017 class of 40 Under 40 by InvestmentNews, which recognizes "accomplishment, contribution to the financial advice industry, leadership and promise for the future." Jeffrey is the Creator and Program Leader for Savvy IRA Planning®, as well as the Co-Creator and Co-Program Leader for Savvy Tax Planning®, both offered through Horsesmouth, LLC. He is a regular contributor to Forbes.com, as well as numerous industry publications, and is commonly sought after by journalists for his insights. You can follow Jeff on Twitter @CPAPlanner.

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(Michael's Note: The video below was recorded using Periscope, and announced via Twitter. If you want to participate in the next #OfficeHours live, please download the Periscope app on your mobile device, and follow @MichaelKitces on Twitter, so you get the announcement when the broadcast is starting, at/around 1PM EST every Tuesday! You can also submit your question in advance through our Contact page!)

#OfficeHours with @MichaelKitces Video Transcript

Today we're going to be talking about interesting question, "Is there an important reason to complete or potentially not complete my rollover prior to the end of the year?" So let's talk about this. Let's talk about why there could potentially be a need to make or not make a rollover prior to the end of the year. And just as a reminder, this is Office Hours with Michael Kitces. Obviously, I'm not Michael Kitces. I'm Jeffrey Levine, director of advisor education for the Kitces.com platform.

Reasons NOT To Complete a 401(k) To IRA Rollover [00:40)

And let's start with some areas where you want to absolutely make sure that you don't make a 401(k) to IRA rollover before the end of the year. The first would be, if you did a Roth conversion earlier this year and you have some after-tax money inside that traditional IRA, one of the last things you probably want to do is move money from the 401(k) over into the IRA now. Why? Well, because that pro-rata rule you might be familiar with in the IRA, that "cream in the coffee" rule that says every distribution you take is a portion of pre and post-tax dollars, it's actually based on the year-end value of the IRA. So, even though you may have converted everything inside the IRA today, if you move a 401(k) over to an IRA now, well, that could add to that year-end balance, and all of a sudden, it could make your conversion a lot less tax-efficient. In addition to that, you might also have a still-working exception available to you in your plan where if you move that over to the IRA, well, you lose out on that still-working exception because there is no still-working exception in the IRA.

Why Roll Over From A 401(k) To An IRA Before The End Of The Year [01:48]

But having said all of that, there are a lot of reasons why making a rollover from a 401(k) to an IRA before the end of the year can be very beneficial. The first off is just simply consolidation and ease, especially if you are 70 1/2 or older. If you're 70 and a half or older, you have required minimum distributions, in general, from all of your retirement accounts. If you've got IRAs, you have to take RMDs from your IRAs. If you have a 401(k), you have to take that RMD separately from each 401(k). If you've got 403(b) plans, you have to take those separately from just the 403(b)s. Well, if you complete those rollovers to an IRA before the end of the year, it makes life a lot easier, right? You don't have to worry anymore about, "Oh, should I take my RMD from this account or this account?" It's very easy. You just take it from any IRA you want, as long as you get the total amount out. Whereas if you leave money in let's say multiple 401(k)s, you will still have to take an RMD from each and every one of those 401(k)s.

In addition, what if you're interested in making a QCD, a qualified charitable distribution, in 2019 but you don't have any IRA money today to do it? One of the things you want to do is to make sure you complete that rollover to the IRA prior to the end of the year. Doing so will give you an IRA balance as of December 31st, 2018 and will make your RMD for 2019 an IRA RMD. See, QCDs, that qualified charitable distribution that allows you to give money directly from your IRA to charity and not include it in your income at all, is only available for IRAs. So if you leave your money in a 401(k) or a non-IRA account as of the end of this year, you're not going to be able to use the QCD in the IRA next year to wipe out your RMD. It's not going to be eligible for that. It would only be eligible to do so the following year. So again, that pre-year-end rollover is important today, potentially, because you can get a benefit next year.

To that point, if you have a lump sum distribution that you've been looking at doing this year, things like NUA, things like pre-74 capital gains elections or even the 1980 or 10-year averaging based on the 1986 tables, all of that could potentially be another reason to get your rollover out of the 401(k) and over to the IRA today.

And finally, I would add a QLAC. What is a QLAC? Well, it's a qualifying longevity annuity contract. And while you can purchase a QLAC in a 401(k) or 403(b), most plans don't offer them as investment options. And so, if you want that or your client wants that, you're probably going to have to do it in an IRA. But the problem is your IRA QLAC amount is limited to the lesser of $130,000 or 25% of your prior year-end IRA balance. What if you don't have a prior year-end balance? Twenty-five percent of zero is zero. So if that's the case and you want to have a QLAC purchase for next year, you've got to make sure that rollover happens before the end of the year this year in 2018.

Something else to consider. If you have somebody who has or if you have multiple accounts and one of those accounts has a beneficiary who is your spouse, who is your sole beneficiary on that account and they're more than 10 years younger than you and you are more than 70 and a half years of age, well, in that case, that 10 years-plus younger spouse allows you to take out a lower RMD each year. But that only works if you're the sole spouse beneficiary or you have as your beneficiary your spouse and they're their sole beneficiary for the entire year. So let's say you have two accounts. One account where your spouse who's much younger, much mean, more than 10 years younger, is your sole beneficiary, and one account where you've got maybe your children or that spouse with other individuals. If you want to delay your RMDs, right? If you want to delay those RMDs, one thing you can consider doing, or at least diminish them, is move more money into that account where that spouse is your sole beneficiary for the entire year.

And then finally, talking about a special type of rollover, a Roth conversion, which is a rollover from a pre-tax account into a Roth IRA, a special type of rollover here is great, right? What could we be doing? Well, we could be doing a conversion before the end of the year because we want to avoid RMDs in 2019, right? 2019 RMDs are based on your year-end value. If you convert before the end of the year, you diminish that amount that you have as a required minimum distribution next year.

Also, remember that the Tax Cuts and Jobs Act created a lower tax rate structure for roughly, you know, three-quarters-plus of the American population this year. Not to say that the tax cut was a good thing or a bad thing. That's a political discussion. We're not going to enter into that today. But the fact is most people do have lower tax rates in 2018 than they did last year. And as it stands now, that window is only through 2025, after which the tax rates of yesteryear come back and we go back to higher tax rates for most individuals. So we may have this limited range from 2018 through 2025 to get conversions out at lower tax rates than before. And obviously, we're not talking about a 50-year span. It's a very short amount of time, so you don't want to miss out on any one of those years if it's a potential benefit to you.

Now, of course, you definitely don't want to do a conversion if it's not going to be tax-efficient. Definitely, don't do that before the end of the year because remember, part of the Tax Cuts and Jobs Act of 2017 said the recharacterization option for Roth IRA conversions is completely eliminated. Can't do it anymore. So if you convert today but you really shouldn't have, unlike years past, you can't go back in April when you do your taxes or even as late as October of next year, you can't go back and undo it like you could in the past. So if adding more income to your return this year is not a good thing, right, it might push you into a higher tax bracket or perhaps put you over a cliff for Medicare Part B premiums, if that's the case, you absolutely don't want to make that Roth conversion before the end of the year.

Rules To Consider When Making Last Minute Rollovers [08:43]

So, having said all of that, let's talk about...finally, let's finish up by talking about some of the rules for these last-minute transactions. For instance, let's say you really do want to get a Roth conversion in for this year but we're bumping up against the end of the year, we've got holidays, how can you ensure that it counts as a Roth conversion for 2018? And the answer is simple. The money has to leave the pre-tax account by December 31st. It doesn't actually have to get to the Roth IRA by that time. It doesn't have to be completed. It just has to leave the pre-tax account by December 31st. And as long as it gets to the other account in a reasonable amount of time if it's a trustee-to-trustee transfer or if it's an indirect rollover, certainly wouldn't recommend that, but if you did a 60-day Roth conversion, obviously, you've got 60 days to get that money back into the Roth account.

Similarly, if you're in the process of moving money let's say from a 401(k) over to an IRA by the end of the year or vice versa, let's say you wanted to move money from the IRA into the 401(k) in order to maximize the still-working exception if you're still working past 70 and a half, well, you want to make sure, again, that the money leaves the other account prior to the end of the year. That's really the key there. If it gets it afterward, it's fine.

Now, if you do have money outstanding at the end of the year, on December 31st, and your client is over 70 and a half years of age, you have to manually add that amount back in when figuring out their RMD calculation. The custodian typically is not going to do that. For argument's sake, let's say you had $100,000 in ABC custodian and your client was moving another $100,000 from their 401(k) over to the IRA and it left the 401(k) on December 30th, but on December 31st, it was kind of in no man's land, it hasn't gotten to the IRA yet but it's not in the 401(k), well, the IRA custodian only knows what the IRA custodian has at the end of the year. They have $100,000. If they calculate that RMD for you or for your client, they're going to base that calculation on $100,000, not $200,000. So when that 401(k) transfer hits the IRA in the following year, you the advisor actually have to make sure that you adjust that prior year balance by that amount. Again, it's not going to be done by the custodian in the overwhelming majority of times.

So again, coming up to the end of the year, lots to think about. Kind of recapping, reasons why you don't want to move your 401(k) to an IRA right now could be, you did a Roth IRA conversion earlier this year and you don't want to impact your conversion with more pre-tax dollars from a 401(k) to impact the pro-rata rule. You also may not want to lose out on the still-working exception if you're still working and over 70 and a half. Why would you, again, recapping, why would you potentially want to do a last-minute rollover from a 401(k) to an IRA? Consolidation and ease of RMDs. That's high on the list. You might want to make a QLAC purchase in 2019, which will be based on your 2018 year-end value. You might want to make a QCD in 2019, which again can only be made from IRA dollars. And you might want to finish completing your lump sum distribution. So those are all reasons potentially to do the 401(k) to IRA rollover now with an urgency before the end of the year.

And similarly, or the opposite vein, you want to make sure that you're doing the IRA to 401(k) rollover prior to the end of the year for two reasons. One would be you did an earlier year Roth conversion and you want to reduce the pre-tax dollars in your IRA. If that 8606 is a year-end form, well, guess what? Moving money out before the end of the year lowers that year-end balance. And also, if you're trying to delay or avoid RMDs next year, getting money into a plan where the still-working exception exists today before the end of the year can allow you to delay RMDs on those IRA dollars today that are moved into the plan before the end of the year.

So there is a good summary of some of the IRA to 401(k) priority moves before the year-end. Always something to talk about. Hopefully, you've picked up something that can help you or your clients and make a difference in their planning. I wish you all the best of luck and have a happy, healthy rest of the year. My name is Jeffrey Levine, director of advisor education here at kitces.com. Have a great day, everyone. Bye-bye.