So, you’ve decided an indirect rollover from your 401(k) is the right choice for you, and you have the distribution check in-hand. Now what?
What Is an Indirect Rollover?
If you change employers, your 401(k) plan will most likely change as well. And when it comes to transferring your funds into another retirement account, there are a couple choices available to you: either a direct or an indirect rollover.
In a direct rollover, retirement funds are transferred directly into another retirement account without you ever having to touch the money. You can also receive a check from your employer made out to the new account, in which case you will receive a check but will deposit it into the new plan — this is still considered a direct rollover because you will never personally receive the funds.
In an indirect rollover, your current plan administrator will liquidate the assets to you, and you will then have the responsibility to deposit the funds into the new retirement account. There are specific rules and regulations you must follow when using this option, so here are the steps you need to take to ensure it’s done correctly.
Determine Where the Funds Are Going
First, you need to determine where you would like the money to go. All or part of the distribution from your 401(k) plan can be rolled over to almost any plan of your choice, including other employer-sponsored 401(k)s, IRAs and designated Roth accounts. The only exception is from a 401(k) to a simple IRA, which can only be done after two years.
Plan for Income Tax
Second, understand the total amount in your retirement account will not be the amount you receive in distribution. Rollover distributions from a 401(k) plan are subject to a mandatory withholding of 20%. This means that if you take $10,000 from your retirement plan, your plan administrator is required to hold $2,000 for taxes, and you’ll receive $8,000. You’ll then be required to deposit the distribution within 60 days, and depending on the amount you deposit, you may have to pay taxes.
Follow the 60-Day Rollover Rule
You have 60 days from the time you receive your distribution check to deposit the funds into your new retirement plan. If you miss this deadline, the Internal Revenue Service (IRA) will treat the withdrawal of these funds as an actual withdrawal, which carries income taxes. And if you’re younger than 59½, your withdrawal will be considered “early” and you’ll have to pay income tax on the entire amount, plus a 10% penalty fee.
Continuing with the $10,000 scenario: if you redeposit the entire amount you withdrew, including the $2,000 withheld within the 60-day limit, you will not be taxed. If you redeposit just the $8,000, you must report the $2,000 as taxable income. And if you’re younger than 59½, you’ll have to pay the 10% penalty fee on top of the taxes paid to the $2,000.
The bottom line — if you’ve chosen to participate in an indirect rollover and wish to avoid taxes, only do so if you are certain you can redeposit the full amount within the 60-day limit. At Wickham Financial and Insurance Services, we can help you determine if an indirect rollover is the right choice for you. We take a holistic approach to your financial wellbeing to understand your specific needs, and we can recommend the best course of action based on your unique circumstances. Schedule an appointment with one of our wealth advisors today so we can talk about your financial future.
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