There are many, many different ways to initiate a 401k rollover. In most cases, the procedure you’ll need to follow will depend on the forms and processes of the institutions that manage both your old 401k account and your new rollover IRA. To simplify matters, your best bet to think of them in stages – making sure that each one is done before moving on to the next one. By following these simple stages, you’ll be able to successfully complete the 401k rollover to IRA, while maintaining the tax deferred rollover status of your investments.
While it may seem simplistic, a very common mistake in the world of rollovers occurs when account holders request a rollover before the target 401k IRA (the account where you’re sending the money) is ready to get the money from the old account. You might be surprised to find out that your new IRA may not immediately be ready to receive a 401k rollover as soon as it’s opened. For example, if your IRA is employer-sponsored, there may be a delay of a few pay periods before you can move your old funds into the new account.
Fortunately, the first step you’ll need to complete in your 401k rollover is to contact the manager of the new, target IRA. He or she will be able to tell you if the account is ready to receive the funds, or, if not, when it will be eligible to receive rollover funds.
When you talk to the account trustee or manager, be sure to ask what kind of account the new one is if you didn’t set the account up on your own. There are rules as to what kinds of IRAs can receive a rollover from a 401k account. Generally, there’s no problem transferring funds between the same kinds of IRAs – known in the financial world as the rule of “like can accept like.” This means that going from one 401k account to another 401k account shouldn’t be a problem. However, if you’re performing a 401k to IRA rollover, you’ll want to check with the manager of the new fund who can advise you about any possible exceptions.
Next comes the important part. Once you’re informed that the target IRA is active and designated to receive the 401k rollover and that no restrictions exist to roll funds out of the 401k IRA, then you need to request a “direct rollover.” This specific wording ensures that the funds will go directly from one account to another. The money will not come into your hands, so you won’t ever see a check or bank deposit. The money will simply move from one account to the next without your intervention.
If the money is sent to you as part of an indirect 401k rollover, the entire tax situation changes. If you, as the account holder, receive the money, the transaction is then classified differently than in the case of a direct rollover. In most cases, the withdrawal will become immediately subject to mandatory withholding. In addition, if you don’t redeposit the money into a qualified retirement savings account, you may find yourself on the hook for ordinary income tax and additional early withdrawal penalties that will dramatically diminish the power of your retirement savings.