I don’t know about you, but when I hear the terms “rollover,” “direct rollover,” “direct payment,” “direct transfer,” and “transfer” used interchangeably, I get worried. True, these terms are all ways to move money between eligible retirement plans and eligible IRAs free from federal income tax, but they do not mean the same thing.

Using one “rollover” term when you really mean another can result in horrible federal income tax consequences to a plan participant or IRA owner and—at the very least—can add unnecessary ambiguity to a situation. Plan sponsors, plan administrators, human resources personnel, trustees, custodians, investment advisors, and anyone else who deals with retirement plans and IRAs need to be careful with the words used in plan and IRA materials (particularly distribution forms, summary plan descriptions, and IRA disclosure statements) and when these terms come up in conversations with plan participants or IRA owners.

Below is a brief and basic summary of typical “rollover” terms (note that special rules for different types of plans and IRAs such as 457 plans, SIMPLE IRAs, and Roth IRAs are not included):

Because “rollover” terminology is confusing (some may say without any really good reason!) and the federal income tax consequences can be truly horrible for the individual if the terms are misused, plan and IRA professionals need to be careful when dealing with “rollover” terminology. Although plan and IRA professionals should also be careful not to offer tax advice to plan participants, IRA owners, or their beneficiaries, when “rollover” terminology is used it needs to be used correctly.

In Part 2 of this series, we’ll review some examples of how things can go horribly wrong for plan participants and IRA owners and their beneficiaries if they misuse “rollover” terms to move money between eligible retirement plans and eligible IRAs.

Part 2- Potential Horrible Consequences