401k Rollover

When most of us talk about a retirement plan rollover, we are thinking about taking money from one retirement plan and transferring it into another plan.  In the real world, the most common rollover scenario would be if you accepted a new job and wished to rollover your 401k plan to your new company or another financial institution.

401k Plan Rules

Most likely your new or former employer's 401k plan administrator can help facilitate this transfer.  But you really need to be careful, or some pretty harsh tax penalties can kick in that might have you scrambling.  This can happen because the IRS takes a pretty cautious approach to any kind of retirement plan rollover.  In fact, they really consider a 401k rollover just like a Lump Sum Distribution until you prove them wrong.

401k Rollover Defined

From the IRS's perspective, a 401k rollover occurs when you withdraw cash or other assets such as stocks, bonds, and mutual fund shares from one qualified employer's 401k plan and contribute all or part of it into another 401k plan, a qualified retirement plan, or a traditional IRA within 60 days.  This is sometimes known as the 60-day rollover rule.  Generally, if you have not reached the magic age of 59 1/2, then contributions you made to your 401k plan on a before-tax basis are eligible for rollover.

This is a pretty important process to follow because the tax penalties are quite unattractive.  In the next several sections we will explain a simple process that you should follow and the "be careful" process that you could be involved in with a 401k rollover.

Direct 401k Rollovers

In a direct 401k rollover scenario, your previous qualifying 401k plan administrator will usually require you to fill out several forms describing the amounts withdrawn, and the account information for the new 401k plan, qualifying plan, or the IRA into which the retirement funds will be deposited.

Direct 401k rollovers are the most convenient way to move money from your existing 401k plan into another retirement account.  With a direct 401k rollover, the money is transferred from one financial institution to another and you should never have to worry about withholding rules or tax penalties.  Unless you need to take possession of the 401k funds in your account for some reason, a direct 401k rollover is really the safest and easiest way to make a transfer.

401k Rollover Payments to Individuals

If you have not reached age 59 1/2 and you chose to have the money in your 401k plan paid directly to you, then it is important that you be aware of immediate tax penalties that kick-in and withhold requirements you'll encounter.  With a 401k rollover that is paid to an individual, there is a mandatory 20% withholding even if you intend to deposit, or roll over, the money into a new retirement plan later on.

When you're doing this kind of 401k rollover, you will have to add funds from other sources to offset the 20% withheld.  If you do not add these funds, then you may be subject to an early withdrawal tax penalty.  Let's look at a quick example to see how this works:

401k Rollover Tax Example

Let's say you've saved $200,000 in your 401k plan and you have the rollover payment sent directly to yourself.  That means you will get a check for $160,000 from that institution - not the full amount of $200,000.  Under the 401k rollover rules, you now have 60 days to deposit the full amount - $200,000 - into another 401k plan, qualifying plan, or IRA to avoid tax penalties.

In this example you need to come up with the $40,000 withheld and deposit this money into your new retirement plan in order to match 100% of the amount withdrawn.  If you have considerable funds in an existing 401k plan, multiply that number by 20%.  This is how much money you need to supplement to avoid tax penalties if you take possession of the rollover money.

401k Taxable Distributions

If you under age 59 1/2 at the time of what is now deemed a 401k distribution, and you are not able to follow this process, the tax penalties will immediately start to take hold.  There are two "penalties" that occur if your rollover becomes a distribution:

• You will have to treat any funds not deposited / rolled over as income for that tax year.
• You will be assessed a 10% early withdrawal penalty on the 401k funds not deposited.

401k Plans and Retirement

It's both fun and exciting to watch the money in your 401k account grow through the years.  It's even more exciting to be offered a new job, a chance to work with new people, and stretch your abilities as a professional at a new company.

But the IRS allows us to deposit money into 401k plans so we can save for those retirement years.  If you withdraw the money before reaching retirement age, as you would with a 401k rollover, they want to make sure that money goes right back into another qualifying retirement plan.

Take the time to understand all the 401k rules and talk to your plan administrators if you have any questions.  You're doing the 401k rollover for the sake of convenience - so you can manage all your retirement funds in one place - don't let it turn into a tax penalty nightmare.

About the Author - 401k Rollover

Bill Sharlow is the Editor of Money-Zine . com

For more info on how to do a 401k rollover or ira rollovers visit 401kRollovers.info