There are a few different ways you can roll over 401(k) funds into an IRA. But if you don’t follow the rules you can expect the money you take from your account to be taxed and penalized. And, there’s no fun in that.
You can choose to move your retirement funds into a new account for a number of reasons. Perhaps you’ve decided it’s more beneficial to use a Roth IRA. Maybe you want to move to a new custodian who allows you to invest in alternative assets instead of the limited stocks and mutual funds your current plan is restricted to. And, of course, if you’re leaving one job for another. But, while changing employers is a common reason many roll over 401(k) funds, it’s not a prerequisite. If your current employee plan allows it, you may be able to shift some or all of those funds into an account outside of your workplace.
Typically, rollovers aren’t a taxable event unless you’re moving funds into a Roth IRA since contributions to that plan type are taxed dollars. You have 60 days from the time you take receipt of the funds from your old account to move them to your new account. If you miss that deadline, then you’re looking at tax plus a 10 percent early withdrawal penalty.
Direct rollovers are the best
Direct rollovers are the preferred transaction when you decide to roll over 401(k) funds to a new account. These transactions are easy and pain-free and incur no taxation or withdrawal penalty.
As the term implies, the current custodian simply moves your funds directly to the IRA with the new custodian at your request. The money never touches your hands and, therefore, no tax or penalty is incurred. This is a relatively quick and easy transaction that can be performed more than once a year.
Indirect rollovers will cost you
Indirect rollovers are a bit of a complicated and costly hassle. Here, the custodian of the plan you’re leaving cuts you a personal check for the funds, in your name. It’s up to you to deposit that money into your new account within 60 days. If you delay past the timeframe, you’ll be taxed and have to pay a penalty, too.
When an employer plan pays the plan owner, tax law requires that 20 percent of the amount is withheld for income tax—even if you roll it over. According to the IRS, “…to avoid taxation on the entire taxable portion you'll have to add funds from other sources equal to the amount withheld.”
Indirect rollovers can only be performed once a year, so bear that in mind if you plan to make this move.
If you somehow fail to deposit your funds in the new IRA by the time limit, you might qualify for a 60-day rollover requirement waiver.
Please contact Advanta IRA if you have questions about IRA rollovers. We are happy to help, and can be reached at 800.425.0653.