Direct IRA Rollovers Can Save You Time and Tax Hassles

Quick Summary

  • When you move money from a 401k to an IRA or another 401k, you have a choice about whether you do an indirect rollover or a direct rollover.
  • In a direct rollover, the money is transferred straight from one account to another. In an indirect rollover, you get a check from your 401k and have 60 days to deposit the money in a different retirement account.
  • A direct rollover triggers no taxes. An indirect rollover has tax consequences.

Introduction: Direct Rollover Or Indirect Rollover

When people leave a job or retire, they often do an IRA rollover. That means they move their money from their 401k into an IRA at a bank or brokerage. Your 401k plan administrator will give you a choice about how to move the money. You can move it in a direct rollover or an indirect rollover.

The money in your 401k is tax-deferred. That means you don’t pay taxes on it until you take it out. If you take it out before age 59 1/2, you will also likely owe a 10% tax penalty.

To avoid paying taxes or the penalty, you should ask for a direct rollover.

If you ask for an indirect rollover, you get the check yourself and taxes are withheld. You can use money in your account for 60 days before you deposit it into another tax-deferred account. You’ll have to report the move on your taxes.

But if you don’t follow the rollover rules on an indirect rollover, it becomes a partial or entire cash out of your account, and you will owe taxes and a penalty on the money.

Cashing out any portion of your retirement account is usually not a good idea. You’ll also be robbing your future self of the money you need to retire.

In this article, we’ll cover the information you need to do a direct or indirect rollover successfully.

Direct Rollovers

Direct Rollovers are simple. You ask your 401 plan administrator to make the payment directly to another retirement plan or to an IRA. Your plan administrator is usually someone who works in human relations at your company. The administrator could also give you a check made payable to your new account, which you give to your new plan’s administrator or deposit in your IRA. You won’t owe taxes in either case.

Indirect Rollovers

In an indirect rollover, the money from your 401k is paid directly to you. Taxes are withheld from the check. You have control of the money for 60 days.

At the end of the 60 days, you have three choices:

  1. You can deposit the money into a new 401k or IRA. You will need to report the amount withheld — say $2,000 — twice on your tax form, once as income and once as taxes paid. In addition, you will pay a 10% penalty on the total.
  2. You can deposit the money into a new 401k or IRA and make up the amount withheld with other funds. If $2,000 is withheld from your check for taxes, you can take $2,000 from elsewhere, add it to the total of your check, and deposit. You’ll report the $2,000 twice, as a nontaxable rollover and as taxes paid. In that case, you won’t owe the 10% penalty.
  3. You can keep the distribution for more than 60 days — but in that case, you’ve cashed out your 401k. That is almost always a mistake. You worked hard to build it up. It’s important to keep it growing so that you have enough in retirement.

The Bottom Line

Your 401k money is yours, and it is growing tax-deferred as long as you keep it in your account, or rolling directly from one tax-deferred plan to another. A direct rollover from a 401k to another 401k or an IRA is easy and there are no tax consequences.

Whenever you take money out of the account, there will be taxes to pay. An indirect rollover allows you to take the money out temporarily, for 60 days, and still avoid taxes. But it is complicated and could cost you money if you’re not careful to follow the rules.

A direct rollover from a 401k to another 401k or an IRA is easy and there are no tax consequences. An indirect rollover gives you control of your money for 60 days. But is more complicated and could cost you money if you’re not careful to follow the rules.

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