The 401k IRA Rollover

Have you ever seen a television commercial, billboard, or newspaper advisement that portrayed a person or company as your 401 headquarters or rollover specialist? The financial services industry has spent a considerable amount of time and energy to create marketing campaigns. These slick advertisements are designed to lure you in so as to roll your retirement or IRA savings from a former employer over to them.

My objective here is to explain the process of a rollover and take away any mystery that you may have about this process. For some, the mystery is about the fear of making a mistake and having to pay substantial taxes and penalties. First, let me start by giving an easy example of why you are not taxed when contributions are made to a retirement plan.

When you are paid by your employer via check or automatic bank deposit, you take immediate possession because the funds are directly paid to you. For federal tax purposes, this is referred to as constructive receipt. If you take constructive receipt of earned income, you are required to pay income taxes.

When contributions are made to a retirement plan (such as a 401k, 403b, or traditional IRA), you have made an election to defer income until a later date. Because you have not taken constructive receipt of the income, you do not pay taxes on this income. It’s that simple!

Now for the rollover. When you deposit money into a retirement plan, someone holds the money for your benefit. This someone has legal financial custody of your money, and this someone is referred to as the custodian of the retirement plan. A custodian is a financial institution that holds customers’ securities for safekeeping and to minimize the risk of being lost or stolen. Depending on the type, some financial custodians may fall under regulation and supervision of the Financial Industry Regulatory Authority (FINRA).

Let’s review. If I take constructive receipt, I pay taxes. If I defer my income by not taking constructive receipt, I defer my taxes. If I establish a traditional IRA or enroll into my employer’s 401k, then the custodian is responsible to oversee my account for my benefit.

If you choose to roll your old IRA over to a new IRA with a different financial custodian, then simply instruct the old IRA custodian to make the check payable to the new custodian for your benefit.  Never have the check made payable to you, unless you want to pay taxes!

Here’s an example. ABC Company is the custodian of your IRA. You, Sara J. Sample, want to roll your IRA from ABC Company to XYZ Company. To accomplish this, you simply instruct ABC Company to issue a check that is made payable to XYZ Company F.B.O. Sara J. Sample. The acronym F.B.O. means ‘for the benefit of’. Please keep in mind that different companies have different procedures to process rollovers. Some companies allow you to process online or by phone whereas other companies require completed paperwork with signatures.

I genuinely hope that this helps to clear up any confusion you may have had regarding the concept of a rollover. Now, you are the specialist!