Tax Rules Governing Rollover Iras
| Publication year | 1990 |
| Pages | 1849 |
1990, September, Pg. 1849. Tax Rules Governing Rollover IRAs
This article summarizes the tax laws that determine when an individual may make a tax-free rollover to an individual retirement account ("IRA") of a distribution received from a retirement plan qualified under § 401(a) of the Internal Revenue Code of 1986, as amended ("Code"). The complexity of these laws, combined with the frequency and importance of retirement plan distributions in tax planning for individuals, makes this subject a common concern of tax practitioners.
A complete explanation of the different tax rules that may apply to a taxable distribution from a retirement plan is beyond the scope of this article. As many as twelve different taxes may apply. Nevertheless, the following brief overview of some of the applicable taxes may help an individual who is considering an IRA rollover to begin understanding the taxes he or she may avoid or defer by making the rollover.
The distribution will be taxed as ordinary income, except that special, more favorable tax rules may apply if the payment qualifies as a "lump sum distribution," as defined in Code § 402(e)(4). These special rules allow certain recipients to elect a 20 percent capital gains tax rate on all or part of the distribution attributable to plan participation before 1974. An individual who is at least age 59 1/2 and who has participated in the plan for at least five years may elect five-year averaging or, if the individual was at least age 50 on January 1, 1986, ten-year averaging. Averaging elections may reduce the overall tax on a distribution.
A 10 percent additional excise tax, imposed by Code § 72(t), applies to distributions received before age 59 1/2 unless the distribution (1) is made due to death or disability; (2) is made due to separation from service after age 55; or (3) is part of a series of substantially equal periodic payments which begin after separation from service and extend over the life or life expectancy of the employee or the employee and a beneficiary. An additional exception is available for any distribution to the extent there is an offsetting medical expense deduction for the employee.
A 15 percent excise tax, imposed by Code § 4980A, applies to "excess" distributions from retirement plans. For 1990, excess distributions are annual distributions exceeding $128,228 or lump sum distributions exceeding $641,140. The 15 percent excise tax is converted to an additional estate tax if the plan participant holds at death "excess" undistributed retirement plan accumulations over an exempt amount determined by a formula described in Code § 4980A(d). The Code and regulations contain many complex exceptions to this 15 percent excise tax.
A rollover to an IRA will defer tax on a plan distribution until payment from the IRA. The subsequent distribution from the IRA is taxed as ordinary income and is subject to the same rules governing the 10 percent and 15 percent taxes described above.
Not all retirement plan distributions may be rolled over tax free into an IRA. To be eligible for rollover, the distribution must fall into one of the following seven categories. In addition, the retirement plan from which the distribution is received must be tax qualified at the time of the distribution.(fn1)
Code § 402(a)(5)(E) allows an IRA rollover by an employee who receives the balance of his or her entire plan benefit in a single calendar year due to the termination of the employer's retirement plan. In the case of a profit sharing or stock bonus plan, the distribution must be due to the employer's complete cessation of plan contributions.
This rule also applies to an employee whose employer is a subsidiary or other member of a controlled group if the employee receives the balance...
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