What Is a Reportable vs. a Non-Reportable Rollover?
The way your retirement funds are transferred dictates the tax implications. Understand the differences to manage your reporting obligations and protect your savings.
Moving retirement funds is a common financial step, often done when changing jobs or consolidating accounts. The process involves transferring savings from a retirement plan like a 401(k) into another, such as an Individual Retirement Arrangement (IRA), to maintain the savings’ tax-deferred status. The method used to move these funds determines the administrative and reporting requirements, and understanding the differences is necessary to avoid unintended tax liabilities.
Direct vs. Indirect Rollovers
When moving money from a workplace plan like a 401(k) to an IRA, you can choose between a direct or an indirect rollover. Both are reported to the IRS, but they have different rules and tax-reporting requirements for the account holder.
Direct Rollovers
A direct rollover, also known as a trustee-to-trustee rollover, is a process where the individual never takes possession of the retirement funds. The money is sent directly from the financial institution holding the old retirement account to the one that will manage the new one. For example, an individual can instruct their former employer’s 401(k) plan administrator to send their savings directly to a new IRA custodian. The check is made payable to the new institution for the benefit of the account owner, not to the individual.
Indirect Rollovers
An indirect rollover occurs when an individual takes temporary possession of their retirement funds, as the plan administrator sends a check for the vested account balance directly to the account holder. This process is subject to two IRS regulations. The first is the 60-day rule, which gives the individual 60 days from receiving the funds to deposit them into another eligible retirement account. If this deadline is missed, the distribution is considered taxable income and may be subject to a 10% early withdrawal penalty if the individual is under age 59 ½.
The second regulation is the mandatory 20% withholding rule for distributions from employer-sponsored plans like 401(k)s. The administrator must withhold 20% of the funds for federal income taxes. For instance, if the total rollover amount is $50,000, the person receives a check for $40,000, with the remaining $10,000 sent to the IRS.
To complete a tax-free rollover of the entire $50,000, the individual must deposit the full amount into the new retirement account within the 60-day window. This requires using $10,000 of personal funds to make up for the amount that was withheld. The withheld amount can be recouped when filing an annual tax return. Failing to make up the shortfall means the $10,000 is considered a taxable distribution.
Tax Forms and Reporting Procedures
After a rollover occurs, financial institutions issue specific tax forms to document the transaction for both the individual and the IRS. The distributing institution sends Form 1099-R. This form details the gross amount of the distribution in Box 1 and contains a distribution code in Box 7 that explains the nature of the transaction. For a direct rollover, this box will show Code G, while an indirect rollover might show Code 1 (Early distribution, no known exception) or Code 7 (Normal distribution).
The receiving institution, in turn, issues Form 5498. This form confirms that a rollover contribution was received and in what amount, as shown in Box 2. It serves as proof to the IRS that the funds distributed from the old account were properly deposited into a new retirement plan.
When filing taxes after a rollover from an employer plan, the transaction must be reported on Form 1040. The total distribution amount from Form 1099-R is entered on the line for pensions and annuities. On the next line for the taxable amount, the taxpayer enters zero, assuming the entire amount was successfully rolled over. To clarify the entry, the taxpayer should write “ROLLOVER” in the space next to the line.