Please note: This article may contain outdated information about RMDs and retirement accounts due to the SECURE Act 2.0, a law governing retirement savings (e.g., the age at which individuals must begin taking required minimum distributions (RMDs) from their retirement account will change from 72 to 73 beginning January 1, 2023). For more information about the SECURE Act 2.0, please read this article or speak with your financial consultant. (1222-2NLK)
If you have a 401(k), you may know you can transfer—or "roll over"—the funds into an IRA. But did you know that rollovers work both ways?
Enter the reverse rollover, which lets you move funds from an existing IRA into your current 401(k), assuming your plan allows it.
Here are two scenarios where a reverse rollover may make sense:
1. You want to delay your required minimum distributions (RMDs)
If you're still working when you reach age 72 and you own 5% or less of your company's stock, your employer may allow you to delay taking RMDs from your 401(k) until you retire.
Unfortunately, you'll still need to take RMDs from your IRAs. "However, rolling an IRA into your 401(k) would allow you to delay those RMDs, too," says Hayden Adams, CPA, CFP®, director of tax and financial planning at the Schwab Center for Financial Research. "This could be ideal for workers whose RMDs would push them into a higher tax bracket."
2. You want to perform a tax-free Roth IRA conversion
If your traditional IRA contains both pretax and posttax contributions, a Roth conversion will be taxable in proportion to the pretax value of the account (known as the pro rata rule).
For example, let's say you have a $400,000 IRA that's 75% pretax contributions ($300,000) and 25% posttax contributions ($100,000). If you converted $100,000 to a Roth IRA, you'd owe tax on 75% of the converted amount. On the other hand, rolling all $300,000 in pretax contributions into your employer's 401(k) could allow you to convert the remaining $100,000 to a Roth IRA tax-free.
Calculating your pro rata percentages can be complex, so it's best to consult with your plan sponsor and a tax advisor before moving forward with a reverse rollover and Roth conversion in order to avoid any unpleasant tax surprises.
Proceed with caution
That said, reverse rollovers do have some drawbacks. For one, your money can be locked up in the 401(k) until you retire, excepting loans and financial hardship.
"IRAs, on the other hand, permit withdrawals at any time—though you'll owe a 10% early-withdrawal penalty if you're younger than age 59 1/2," Hayden says. "Plus, IRAs generally have more investment options than 401(k)s, so bear that in mind when weighing your options."
How much will you need to retire?
More from Charles Schwab
How Does SECURE 2.0 Help 70-Somethings Save More?
6 Things to Do If You're Nearing Retirement
Are Crypto and Retirement Savings a Risky Mix?
Related topics
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.
Roth IRA conversions require a 5-year holding period before earnings can be withdrawn tax-free and subsequent conversions will require their own 5-year holding period. In addition, earnings distributions prior to age 59½ are subject to an early-withdrawal penalty.
0322-13UP