Many of you are familiar with rolling over a former employer 401(k) to an IRA. This is very common. But does it ever make sense to do the opposite, i.e., roll over/ transfer an IRA to a 401(k)? This is sometimes called a ‘reverse rollover’, and the answer is YES. Here are a few circumstances when it can make sense to transfer your IRA to a 401(k):
To Avoid/Delay Required Minimum Distributions (RMD’s)
I realize for those of you who are in their 20’s and 30’s could care less right now about required minimum distributions (RMD’s) from a retirement account, but we have many clients who are in their 60’s for whom this is a soon-to-be reality. For many of our clients, being forced to take a distribution and pay taxes is the last thing they want to do. And although it was a small victory thanks to the Secure Act which pushed the age back to 72 (used to be 70 ½), in today’s 2020 job market, more and more Americans are working into their 70’s. So this added 18 month extension is somewhat helpful, but if you’re working in your 70’s, and you’re still in a higher income tax bracket than maybe your retired friends, having to pay tax on RMD’s while you’re still working can be difficult. The solution?
Transfer your IRA to your company 401(k). Most company 401k plans allow IRA rollovers and don’t require you to take RMD’s if you’re still working for your employer. By rolling over your IRA to your company 401(k), you delay/avoid taking RMD’s, and you reduce your tax bill for that year.
For example, if you have $100,000 traditional IRA and you reach the age of 72, you must begin taking taxable distributions on that $100,000. In the early years, it might $2,000-$3,000 annually, but by the time you reach your late 70’s it will continue to increase (based on your life expectancy and other actuarial metrics). If you’re still working in your 70’s, rather paying on taxes on IRA distributions you might not need or want, and paying higher tax rates than you intended, by doing a ‘reverse’ rollover and moving the $100,000 IRA to your company 401(k), you avoid taking RMD’s (and the taxes too).
As a side note, although you could transfer/rollover your IRA to a Roth IRA and avoid RMD’s indefinitely, you have to pay tax on the amount transferred/rolled over to a Roth IRA (and that’s tough when you’re still working and maybe in a higher tax bracket because you’re still working.)
To Avoid Tax on a Backdoor Roth IRA Contribution
We love Roth accounts. There are a number of ways to fund a Roth account (direct contributions, rollovers, conversions, etc.). The problem for many high income earning Americans is you can’t make a direct contribution to your Roth IRA if you make too much money ($205,000 for married couples / $139,000 if single). Enter the ‘back door Roth IRA’. It’s a great strategy, and it works great, IF, you don’t already have a bunch of traditional IRA dollars in your IRA. If you do, then when you initiate the backdoor strategy by making a non-deductible contribution, the IRS pro-ration rules require you to convert the traditional dollars to Roth (and pay tax) before you can move the non-deductible dollars to Roth (which isn’t taxable). The solution?
The rollover of your Traditional IRA dollars to your 401(k). By doing that, you can easily finish the back door Roth strategy by moving the non-deductible dollars to a Roth IRA without paying any taxes.
For example, if you have $94,000 in your traditional IRA, and you want to fund a Roth IRA, but you make too much money to make a Roth IRA contribution, the only way you can do that is via the ‘backdoor’ option. So in this strategy, you would make a $6,000 nondeductible contribution. You can’t simply move the $6,000 nondeductible contribution to the Roth IRA. It’s not that simple. If you instruct your IRA custodian to move $6,000, they have to pro-rate that and basically treat 94% of it as being taxable and only 6% is not taxed. But if you do a ‘reverse’ rollover first and move the $94,000 from your traditional IRA to your 401(k), and then instruct your IRA custodian to move the $6,000 remaining into the Roth IRA, 0% of that $6,000 is taxed.
If and When You Become an Entrepreneur and Decide to Adopt a Self-directed Solo 401(k)
Let’s say your employer 401(k) plan doesn’t let you rollover your IRA to your employer 401(k) (most do, some don’t). If you’re a business owner, even if it’s a side hustle and even if it’s a brand new business, and your business adopts a self-directed solo 401(k), you can rollover your IRA to a self-directed solo 401(k). Not only will this help you accomplish the first two reasons above (avoid/delay RMD’s, and make the Roth backdoor strategy less taxing), but also provides a way for you to invest in what you know. If you move your IRA to your employer’s 401(k) plan, you’ll be stuck investing in stocks, bonds, and mutual funds. The solution?
Setup a self-directed solo 401(k) and rollover your IRA to this self-directed solo 401k. By so doing, you can use those funds to invest outside of the stock market and invest in things like real estate, privately held companies, hard money lending, etc. The most successful/biggest retirement accounts are typically self-directed because the account owner has maximum flexibility to invest in what they know (subject to the prohibited transaction rules).
For example, if you have $94,000 in your traditional IRA and you do a ‘reverse’ rollover into a self-directed solo 401(k), not only do you #1 avoid/delay RMD’s on that $94,000 and #2 allow you to implement the backdoor Roth IRA strategy (#2 above), but #3 now you have $94,000 in a self-directed retirement account that you can invest in what you know (real estate, etc.).
As a side note, of course you could rollover your IRA to a self-directed IRA and by so doing, you would be able to invest in what you know, but you don’t solve the RMD problem, or the backdoor Roth issue, not to mention the other items on this list.
If You’re Living in a State that Provides Stronger Creditor Protection for 401(k)’s than IRA’s
Many of our clients are always looking for better asset protection. One of the best ways to build wealth, save taxes, and protect assets is to have retirement accounts. But some states don’t provide strong asset/creditor protection for IRA’s. The solution?
Do a reverse rollover into a 401(k). Some states provide stronger creditor/asset protection for 401(k)’s and ERISA based plans than for an IRA. If you live in one of those states, if you do a ‘reverse’ rollover and move your IRA to a 401(k), you can receive stronger creditor protection for your retirement account.
For example, if you had $100,000 in an IRA and were living in a state that only protected ERISA retirement accounts from creditors, in a lawsuit, potentially that $100,000 is at risk of being used to satisfy/payoff a judgment, but by doing a ‘reverse’ rollover into your employer 401(k), your $100,000 would be safe from creditors.
If You Want to Borrow from Your Retirement Account
Typically, you cannot obtain a tax-free loan from an IRA. The solution?
Rollover your IRA to a 401(k). With most 401(k)’s, you can borrow up to $50,000 or 50% of your account, whichever is less. That’s a tax-free loan that you can use a number of different ways, including to start a business, to pay off debts, etc.
For example, if you had $100,000 in an IRA, you typically can’t use that money to fund your own business or borrow from it, but by doing a ‘reverse’ rollover into a 401(k), you could then borrow $50,000 as a loan (non-taxable distribution) to pay off high interest debts, start a business, etc.
What’s the Takeaway?
In sum, there are many benefits to doing a ‘reverse’ rollover i.e., rollover an IRA to a 401(k), including avoid/delaying RMD’s, doing a backdoor Roth without paying taxes, investing in what you know, receiving potentially stronger creditor protection, and the ability to obtain a tax-free loan. If you have any questions, please contact our office at www.kkoslawyers.com.