Do I Pay Taxes When I Rollover a 401(k) to an IRA?

If you participate in your company’s 401(k) plan, managing your retirement savings when you change jobs is one of the biggest decisions you will face. Rolling over your 401(k) to an individual retirement account (IRA) is one of the options available to you. If you are considering transferring your employer-based retirement account to an IRA, be aware that tax implications vary depending on the type of IRA you choose and how you handle the rollover.

401(k) to Traditional IRA

Your 401(k) contributions are paid into your 401(k) account on a pre-tax basis. Because contributions to a traditional IRA are also paid pre-tax, it is possible to roll over your 401(k) to a traditional IRA without incurring taxes provided you follow the appropriate procedures. Before leaving your company, consult with your 401(k) plan manager to determine how retirement account transfers are conducted.

Direct Rollover or Trustee-to-Trustee Transfer

The easiest way to avoid taxes on a 401(k) to a traditional IRA rollover is to move funds from the old account to the new account through a direct rollover or trustee-to-trustee transfer. In both of these methods, the funds from your 401(k) transfer directly from your previous company’s plan manager to your new IRA account without you ever taking possession of the funds.

Indirect Rollover

In some cases, you may be required to act as an intermediary and take possession of your retirement funds before they are deposited into your new account. This process is known as an indirect rollover. Be aware, tax implications when utilizing this method are more complex. Once you receive the check, you have 60 days to deposit the funds into a new retirement account or you will owe taxes on the entire amount. Depending on your situation, your previous plan manager may be required to retain a 20% withholding tax on your savings. If you are subject to withholding tax, you must make up for the withheld amount with your own funds to avoid paying taxes on the retained amount. Due to the complexity of the indirect rollover and 60-day rule, we highly recommend you consult with one of our financial planners at Wickham Financial & Insurance Services.

401(k) to Roth IRA

One of the differences between a Roth IRA and a traditional IRA is that contributions to a Roth IRA are made on an after-tax basis as opposed to a pre-tax basis with a traditional IRA. As a result, transfers from a 401(k) to a Roth IRA are handled differently than transfers to a traditional IRA. Because you are going from a pre-tax contribution account to an after-tax contribution account, you will be required to pay taxes on a portion of the funds you transfer to make up for the difference in the tax status of the contributions. Because of the tax implications for a 401(k) to a Roth IRA rollover, it may be best to rollover your 401(k) to a traditional IRA and later convert the traditional IRA to a Roth IRA if you prefer a Roth IRA.

Managing your 401(k) when changing jobs requires a degree of research on your part to ensure you make the best decision for your future. At Wickham Financial & Insurance Services, our team can explain the pros and cons of all the options available to you and help you make the best choice based on your individual needs.

Any information provided has been prepared from sources believed to be reliable but is not guaranteed, does not represent all available data necessary for making investment decisions and is for informational purposes only.