Since 401(k) plans are employer-sponsored, your plan won’t stay the same every time you change jobs. Fortunately, he won’t have to go through life trying to keep up with every 401(k) he’s ever had; he can do a rollover.
A rollover occurs when you transfer money from one 401(k) plan to another. There are a couple of options when making a transfer, but here’s why you should reconsider an indirect transfer.
You have to follow the 60 day rollover rule
You may find yourself in a situation where you prefer to handle the transfer yourself, known as an indirect rollover. With an indirect transfer, your old plan provider will liquidate your plan assets and then send you the money to deposit into your new account. When you make an indirect transfer, you have 60 days from the date you receive the money to deposit it into your new plan (or redeposit it into your old account).
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If you don’t deposit the money within 60 days, it’s considered a withdrawal and you’ll have to pay income taxes on the full amount. People under the age of 59 1/2 will also receive the 10% early withdrawal penalty. Depending on how much you’re transferring, breaking the 60-day rule could result in you owing a significant amount. Not even considering income taxes due, the 10% early withdrawal fee alone would be $10,000 on a $100,000 rollover.
Some money will be withheld for tax purposes
Every time your 401(k) plan provider sends you money, the IRS requires them to automatically withhold 20% of the total amount. So if you transfer $100,000, you will only receive $80,000. To make matters worse, you’ll also have to offset the amount withheld when you put the money into your new plan. Here are the three tax scenarios you may find yourself in when making an indirect transfer:
- You won’t owe any tax if you add $20,000 to the $80,000 you received and deposit the entire $100,000 into your new account.
- If you deposit the $80,000 and not the $20,000 withheld, the $80,000 will not be taxed, but you will owe taxes on the $20,000 (and possibly face the 10% early withdrawal penalty).
- If you don’t redeposit any of the $100,000 within the 60-day period, you must report the $100,000 as taxable income and the $20,000 withheld as taxes paid.
Stick to direct transfers if you can
With a direct transfer, you don’t touch the money while it’s being transferred; it goes from one plan to another without you having to do a lot of work. There may be a case where your old plan’s provider can’t do a plan-to-plan transfer, so they’ll write a check in your new plan’s name and ask you to send it to them, but that’s still considered a transfer. direct transfer because you never “owned” the money; the check was made payable to your new plan provider.
Some people do indirect rollovers because they want to be able to use the money in that 60-day grace period, but if your goal is to transfer money from one account to another, you’re probably better off doing a direct rollover. . You don’t have to worry about missing the 60-day window, and there’s less chance of something going wrong.
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