3996 / What is a rollover or rollover contribution and what are its tax effects?

A rollover or rollover contribution is the transfer of a distribution from a qualified plan, an IRC Section 403(b) tax sheltered annuity, an individual retirement plan, or an eligible Section 457 governmental plan. Distributions that are rolled over according to applicable IRC rules and regulations are not included in gross income until receipt at some time in the future ( Q 3998). A rollover to a Roth IRA generally is a taxable event ( Q 3662).

Once funds or properties are rolled over to an eligible retirement plan ( Q 4000), they generally are subject to the tax treatment given that plan.¹ Different rules apply to distributions made from a traditional IRA to an eligible retirement plan other than an IRA. The portion of a distribution that is rolled over to an eligible retirement plan generally will be treated as coming first from nonafter-tax contributions and earnings in all of the IRAs of the owner.² This rule effectively allows the owner to rollover the maximum amount permitted ( Q 3671).

A direct distribution from a traditional IRA or a Roth IRA to a charity will be tax-free if it meets the requirements of the qualified charitable distribution rules available in 2006 and thereafter ( Q 8112).

It is the responsibility of a plan administrator to determine whether a rollover it accepts is an eligible rollover distribution ( Q 3998) and plans that accept invalid rollovers can face disqualification. Regulations state that a receiving plan will not be disqualified for accepting a rollover that fails to meet the requirements for an eligible rollover distribution if the plan administrator reasonably concluded such requirements would be met and distributed the amount of the invalid rollover contribution, plus any earnings, to the employee within a reasonable time after the administrator determined that the contribution was an invalid rollover contribution. It is not necessary that a distributing plan have a determination letter with respect to its status as a qualified plan for the administrator of a receiving plan to reasonably conclude that a contribution is a valid rollover contribution.³

Although the IRS generally takes the position that the right to a rollover is personal to an employee and cannot be exercised by anyone else, except in the case of a spousal rollover ( Q 4014), at least one court has held that where an employee received a qualifying rollover distribution but died before making the rollover, the employee’s executor could complete the rollover, as long as the 60-day period had not expired.⁴

There are requirements for a direct rollover option ( Q 4001) and rules regarding the application of a mandatory income tax withholding rate of 20 percent on rollovers not made through a direct rollover ( Q 4004). In some cases, a nonparticipant in a qualified plan may roll over amounts received from a plan by reason of a divorce or separation agreement ( Q 4005).