Profit Sharing Plan Rollover to IRA: A Comprehensive Guide

A profit sharing plan rollover to an IRA can be a bit complex, but don't worry, we've got you covered. You can roll over your profit sharing plan to an IRA in a few different ways.

First, you'll need to choose between a traditional IRA and a Roth IRA. A traditional IRA allows you to deduct your contributions from your taxable income, while a Roth IRA allows you to contribute after-tax dollars, but you won't have to pay taxes on withdrawals.

In either case, you'll need to meet the eligibility requirements for an IRA, which include being under 70 1/2 years old and having earned income.

If you receive a profit sharing plan distribution and taxes were withheld, you can roll over the remaining amount within 60 days, but you'll need to make up for the amount withheld with other funds.

You'll report the withheld amount as taxable income, the rolled-over amount as a nontaxable rollover, and the withheld amount as taxes paid.

If you roll over the full amount, including the 20% withheld, your entire distribution will be tax-free, and you'll avoid the 10% additional tax on early distributions.

Here's an example of how this works:

If you don't make any election regarding your profit sharing plan distribution, the plan administrator will give you a written explanation of your rollover options, including your right to have the distribution transferred directly to another retirement plan or to an IRA.

If your plan account is between $1,000 and $5,000, the plan administrator may deposit the money into an IRA in your name if you don't elect to receive the money or roll it over.

You can roll over all or part of any distribution from your IRA except required minimum distributions or distributions of excess contributions and related earnings. This means you have more flexibility with an IRA than with a retirement plan.

To get a distribution from a retirement plan, you typically have to meet the plan's conditions for a distribution, such as termination of employment. But with an IRA, you can set it up and start investing right away.

IRAs give you the most control over your money and the greatest number of options for investing. You can choose from a wide range of assets, including stocks, bonds, certificates of deposit, mutual funds, exchange-traded funds, real estate investment trusts, and annuities.

Here are some examples of assets you can include in your IRA portfolio:

If you want to set up a self-directed IRA, you can even purchase some alternative investments like oil and gas leases, physical property, and commodities.

Tax implications are a crucial aspect of a profit sharing plan rollover to an IRA. If you receive a distribution from a profit-sharing plan, you'll pay income taxes on it, assuming the plan is structured as a pre-tax 401(k) plan.

The taxes owed will depend on your income level and the distribution amount. For example, if you take a $10,000 distribution, your income would be $60,000 for the year, and you'd be taxed at the $60,000 rate.

You may also be subject to a 10% penalty tax on early distributions, unless you qualify for an exception. This penalty tax is in addition to any income taxes owed.

If you roll over the full amount of the distribution, including any taxes withheld, your entire distribution would be tax-free, and you'd avoid the 10% penalty tax on early distributions.

Here's a breakdown of the tax implications:

Keep in mind that tax laws and regulations can be complex, so it's always a good idea to consult with a tax professional to ensure you're meeting your tax obligations and taking advantage of any available tax benefits.

Reporting to the IRS is a crucial step in managing your tax implications. You'll need to report your rollover on your federal tax return.

Your rollover isn't taxable unless it's from a non-Roth account to a Roth account, but it should still be reported on your tax return. This includes any distributions that aren't rolled over into a new account.

You'll need to include the taxable amount of any non-rolled over distribution as income for the year. This can help you avoid any penalties or fines down the line.

You can avoid taxes on a retirement plan distribution if you roll it over directly to another retirement plan or an IRA.

Taxes will be withheld from your distribution if you receive a check payable to you, but not if you do a trustee-to-trustee transfer to another IRA.

You can roll over a distribution from a retirement plan, but you'll need to use other funds to make up for the amount withheld.

If you roll over the full amount of a distribution, including the 20% that was withheld, your entire distribution will be tax-free, and you'll avoid the 10% additional tax on early distributions.

Here are some examples of how taxes will be applied if you roll over a partial distribution:

Note that if you receive a distribution from an IRA and you made an IRA-to-IRA rollover in the preceding 12 months, you must include the amounts in gross income.

The one-per-year rule has a fascinating background that's worth understanding. This rule limits taxpayers to one IRA-to-IRA rollover in any 12-month period.

The basic rollover rule allows you to deposit IRA funds into another eligible plan within 60 days without including the amount in your gross income. However, the one-per-year rule puts a cap on this flexibility.

Internal Revenue Code Section 408(d)(3)(B) is the governing statute that enforces this limitation. Proposed Treasury Regulation Section 1.408-4(b)(4)(ii) and IRS Publication 590-A also provide guidance on this rule.

A key point to note is that this limitation applies on an IRA-by-IRA basis. This means a rollover from one IRA to another won't affect a rollover involving other IRAs of the same individual. However, the Tax Court has held that you can't make a non-taxable rollover from one IRA to another if you've already made a rollover from any of your IRAs in the preceding 1-year period (Bobrow v. Commissioner, T.C. Memo. 2014-21).

A direct rollover is an electronic transfer from your old account to your new account, or a check made out to your new account. This approach is the safest and most tax-efficient way to roll over your profit sharing plan to an IRA.

You have three options to complete a rollover: direct rollover, trustee-to-trustee transfer, and 60-day rollover. A direct rollover is the safest approach, shifting assets directly from one custodian to another without selling anything.

Here are the steps for each option:

Remember, a direct rollover (no check) is the safest approach, and taxes will be withheld from a distribution from a retirement plan if you choose the 60-day rollover option.

To complete a rollover, you have a few options to consider. A direct rollover is an electronic transfer from your old account to your new account, or a check made out to your new account.

You can ask your plan administrator to make the payment directly to another retirement plan or to an IRA, and they may issue your distribution in the form of a check made payable to your new account. No taxes will be withheld from your transfer amount.

A trustee-to-trustee transfer is another option, where you ask the financial institution holding your IRA to make the payment directly from your IRA to another IRA or to a retirement plan. No taxes will be withheld from your transfer amount.

If a distribution from an IRA or a retirement plan is paid directly to you, you can deposit all or a portion of it in an IRA or a retirement plan within 60 days. Taxes will be withheld from a distribution from a retirement plan, so you'll have to use other funds to roll over the full amount of the distribution.

Here are the steps to complete a rollover:

To offer direct rollover, you must have a qualified plan. This includes traditional 401(k) and 403(b) plans, as well as some 457 plans and the Thrift Savings Plan.

Direct rollovers are only available for eligible plans, and not all plans qualify. For example, IRAs, Roth IRAs, and annuities do not qualify for direct rollovers.

Your employer must offer direct rollovers, but they are not required to offer them. If they don't, you may be able to use a trustee-to-trustee transfer instead.

If you're in a high tax bracket now and expect to need the funds in less than five years, a Roth IRA may not make sense. You'll pay a high tax bill upfront and then lose the anticipated benefit from tax-free growth that won't materialize.

A traditional IRA is usually a better option if you're in a high tax bracket now, but expect to be in a lower one in the future. You'll pay taxes on the withdrawals later, but at a lower rate.

You can split your distribution between a traditional and a Roth IRA if you want the benefits of both.

If you're in a high tax bracket now, a Roth IRA might not be the best choice if you expect to tap into the funds in less than five years.

You'll pay a high tax bill upfront, and then you won't get the benefit of tax-free growth because the funds won't have time to mature.

If you're in a modest tax bracket now but expect to be in a higher one in the future, the tax cost now might be small compared to the tax savings down the road.

You'll only pay taxes on the rollover now, but you'll save money in the long run because you won't have to pay taxes on the withdrawals.

Withdrawals from a traditional IRA are subject to regular income tax plus a 10% early withdrawal penalty if you're under age 59½.

Withdrawals from a Roth IRA of your after-tax contributions are never taxed, but you might be taxed if you withdraw earnings on the contributions before you've held the account for five years.

If your 401(k) plan was a Roth 401(k), it can only be rolled over to a Roth IRA, and you won't pay any tax on the rollover to the Roth IRA.

Converting a traditional 401(k) to a Roth IRA is a two-step process - first, you roll the money over to an IRA, then you convert it to a Roth IRA. You won't pay taxes if you roll over between accounts that are taxed in similar ways, such as a traditional 401(k) to a traditional IRA or a Roth 401(k) to a Roth IRA.

If you're in a high tax bracket now and expect to need the funds in less than five years, a Roth IRA may not make sense because you'll pay a high tax bill upfront and then lose the anticipated benefit from tax-free growth that won't materialize.

You can split your distribution between a traditional and a Roth IRA, choosing any split that works for you, such as 75% from a traditional IRA and 25% from a Roth IRA.

Your rollover isn't taxable unless it is from a non-Roth account to a Roth account, but it should be reported on your federal tax return.

You can receive a cash distribution from your profit sharing plan, but be aware that you'll pay a 10% penalty tax if you don't qualify for an exception.

A cash distribution is also known as a profit sharing cash out, and it allows you to receive a portion of your account balance.

You'll need to check with your 401(k) administrator and employer's rules to see what's allowed, as employers have flexibility when creating these plans.

Two types of distributions are permitted from 401(k) plans: financial hardship withdrawals and penalty-free withdrawals.

Financial hardship withdrawals are allowed for reasons such as buying a primary residence, preventing foreclosure or eviction, paying college tuition, and paying un-reimbursed medical expenses.

You may qualify for a penalty-free withdrawal if you meet one of the following exceptions: becoming totally disabled, being in debt for medical expenses, being required to give the money to your divorced spouse or dependent, being separated from service after turning 55, or setting up a payment schedule to withdraw money in substantially equal amounts over the course of your life expectancy.

Here are the reasons for a financial hardship withdrawal: