In a 401k rollover, you transfer funds from one 401k account to another type of retirement account. But,
the IRS has certain rules that you must follow when you’re rolling over your 401k. It’s important that your
401k rollover is done properly. Mistakes can be treated as an early distribution and would leave you
subject to taxes and early withdrawal penalties.
Here are the basic 401k rollover rules:
- You’re typically eligible for a 401k rollover if you’re under age 59 ½.
- You have 60 days to make the rollover.
- You must rollover to another qualified employer’s 401k plan, a traditional IRA, or another qualified
There are two basic 401k rollover options. You can do a direct rollover where funds are automatically
transferred from your old plan into a new plan. Or, you can do an indirect rollover where you get a check
for 80% of your amount and make a 100% rollover into a new retirement plan.
Direct 401k Rollover
A direct 401k rollover is perhaps the easiest way to rollover assets from your old 401k plan. To do the
rollover, you’ll have to fill out some paperwork with the previous 401k plan administrator letting them
know how much money should move over and where the funds should be moved to. The financial
institution makes the transfer and since you never have to make a withdrawal to do the rollover, there’s
less risk of taxes or penalties.
A direct 401k rollover is typically best the option because you avoid the withholding and fees that come
with an indirect 401k rollover (discussed next). There’s no limit on the number of direct 401k rollovers
you can do a year, so if you’re moving from job to job, you don’t incur a rollover penalty each time you
Indirect 401k Rollover
If you plan to rollover the funds yourself, you’ll need to
withdraw the funds from the 401k plan. However, there’s
a major drawback to this method – the plan administrator
is required to withhold 20% of the withdrawal, even if
you’re rolling over to the new retirement plan. Even
though there’s a 20% withholding, you’re still expected to
make a 100% rollover to the new account. That means
you have to make up that 20% withholding some other
way. Fortunately, you can get a credit for the $20,000
on your taxes for that year as long as you complete the
rollover within 60 days.
For example, if you plan to rollover $100,000, your plan
administrator will send you a check for $80,000 and
withhold $20,000. You then have 60 days to deposit $100,000 in a new retirement plan or else you’ll
face tax penalties. You’re not eligible to take a 401k distribution until you reach age 59 ½, so if you don’t
rollover funds within 60 days, you’ll have to include the withdrawal in your taxable income and you’ll pay a
10% early withdrawal penalty (in addition to the 20% withholding).
If you’re over age 70 ½ and no longer working you’ll also be required to take your required minimum
distribution (RMD) before you can rollover the 401k. The RMD is based on the size if your account and
life expectancy based on IRS rules.
When you’re deciding where to rollover your funds, make sure you consider the fees. Some types of
retirement plans have higher fees making them a less attractive vehicle for housing your 401k funds.
Rolling your 401k into an IRA may give you more investment options (and it’s the only option if you’re still
unemployed or your new employer doesn’t have a qualified plan available for you), but you might also
face higher fees with this choice. This option gives you a broad choice of investment choices.
You don’t have to rollover your 401k just because you’ve left your employer. If you have more than $5,000
invested in your 401k, you may be able to leave your funds where they are. You’ll still accumulate interest
and you can make the rollover later.
You don’t want to cash out your 401k, though, unless you’re facing an extreme financial emergency that
can’t be solved any other way. If you don’t do the rollover, you’ll owe the government and you’ll have to
pay a penalty if you haven’t reached retirement age.
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401K Rollover Rules
If you’re interested in rolling over your 401k retirement
plan there are certain rules that need to be followed.
Here are the 401k rollover rules that must be