Since 401(k) plans are employer-sponsored, your plan won’t remain the same whenever you switch jobs. Luckily, you won’t have to go through life trying to keep up with every 401(k) you’ve ever had — you can do a rollover.
A rollover occurs when you transfer the money from one 401(k) plan to another one. There are a couple of options when doing a rollover, but here’s why you should reconsider an indirect rollover.
You have to follow the 60-day rollover rule
You may find yourself in a situation where you’d prefer to handle the transfer yourself, which is known as an indirect rollover† With an indirect rollover, your old plan provider will liquidate the assets in your plan and then send you the money to be deposited into your new account. When you do an indirect rollover, 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 owe income taxes on the full amount. People under age 59 1/2 will also get hit with the 10% early withdrawal penalty. Depending on how much you’re rolling over, failing to follow the 60-day rule could result in you owing a sizable amount. Not even considering the income taxes owed, the 10% early withdrawal fee alone would be $10,000 on a $100,000 rollover.
Some money will be withheld for tax purposes
Whenever your 401(k) plan provider sends you the money, the IRS requires that they automatically withhold 20% of the total amount. So, if you’re transferring $100,000, you’ll only receive $80,000. To make it worse, you’ll also have to make up the withheld amount when you deposit the money into your new plan. Here are the three tax scenarios you can find yourself in when doing an indirect rollover:
- You won’t owe any taxes if you add $20,000 to the $80,000 you received and deposit the full $100,000 to your new account.
- If you deposit the $80,000 and not the $20,000 withheld, the $80,000 will be nontaxable, but you’ll 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’ll have to report the $100,000 as taxable income and the $20,000 withheld as taxes paid.
Stick with direct rollovers if you can
With a direct rollover, you don’t touch the money while it’s being transferred; it goes from one plan to the next without you having to do much work. There may be a case where your old plan provider can’t do a plan-to-plan transfer, so they’ll write a check in your new plan’s name and have you forward it to them, but that’s still considered a direct rollover because you never “possessed” the money — the check was written 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 just to get the money from one account to the other, you’re likely better off doing a direct rollover . You don’t have to worry about missing the 60-day window, and there’s less of a chance that something goes wrong.
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