Why transferring your IRA into your 401(k) plan might be a smart move

The reverse rollover is a financial strategy that involves transferring your IRA assets into your company’s 401(k) plan.

If this is the first time you’ve heard of this approach, you’re not alone.

“The average retirement-minded taxpayer thinks that there is something inherently wrong with combining different types of retirement accounts,” says Kory Klein, CPA, a Principal in the Business Management division at RBZ. “While that is true for many retirement accounts, it is not true for all.”

Smart Business spoke with Klein about what you need to know when deciding if a reverse rollover is right for you.

What are the benefits of doing a reverse rollover?

Company 401(k) plans offer benefits that individual IRAs do not.

You can take distributions from a 401(k) plan without a 10 percent penalty once you are 55 years old and have separated from your employer.

With certain exceptions, you cannot take money out of an IRA without penalty until age 59 ½.

The funds in your 401(k) plan also have greater protection against legal judgments. If it was set up under the Employee Retirement Income Security Act (ERISA), then it is usually protected from creditors.

Most people wrongly assume that their IRAs are protected against legal judgments. If your retirement account is not qualified or covered by ERISA, then a creditor could potentially seize it.

You may find that your company’s 401(k) plan has better investment choices at a lower cost than what you could find on your own.

How do I know if a reverse rollover is right for me?

You may get better investments cheaper. If you work for a large company, there is a good chance that it has put some effort into making sure you have state-of-the-art investment choices. You probably have separately managed accounts within your 401(k). There are portfolios of investments created for your plan that cost less than mutual funds.

You may also want to consider the Back Door Roth strategy.

What is the Back Door Roth strategy?

You can’t make Roth contributions if your income exceeds certain limits.

The Back Door Roth strategy involves making a contribution every year to a traditional IRA and then converting that to a Roth IRA, with the goal of paying little or no tax on the converted amount that has not yet been taxed. The maximum contribution for any type of IRA is $5,500 plus an extra $1,000 “catch-up” contribution if you’re at least age 50.

Usually, when a retirement account has both pre-tax and after-tax money, withdrawals are partially taxable and a calculation needs to be made to determine the taxable portion. The reverse rollover enables the pre-tax and after-tax dollars to be split.

The 401(k) can only accept pre-tax dollars, so that’s an easy way to split it. All the money that’s left in the IRA is after-tax dollars. Therefore, you can move the percentage of money attributed to the deductible contributions plus earnings into your 401(k).

You can then convert the remaining, nondeductible contributions to a Roth IRA. Because the tax has already been paid on these contributions, there is no tax on the Roth conversion.

What do investors need to know before moving forward with this strategy?

If you have older IRAs, you have to pro-rate the amount you convert among all of your IRA money and not just pull from your latest contribution. That could result in a sizable tax bill, as the older IRA money has probably accumulated untaxed earnings that will have to be taxed as they are moved to the Roth.

Here is where the reverse rollover helps: You can move all of your old IRA money into your 401(k). From then on, make the contribution to the traditional IRA and then convert it to the Roth IRA. This way, there will not be any old tax-deferred IRA money to which you will have to allocate a portion of your Roth conversion.

A high-earning couple over 50 could put $13,000 a year into Roth accounts while paying little, if any, extra tax.

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