Is a Reverse Rollover Right for You?
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:
- 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.”
- 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 59½,” Hayden says. “Plus, IRAs generally have more investment options than 401(k)s, so bear that in mind when weighing your options.”