There are so many rules surrounding 401k IRA rollovers that it can be difficult to know what to do when you find that you need to rollover your current retirement plan into another one. The best way to find your way through this financial maze is to understand a few of the basic principles of transferring your 401k plan. One of the first things that you should know is that when you rollover from a 401k to IRA, you won’t have to pay taxes – as long as the money is transferred to a qualified plan.
Something else to remember about 401k rollovers is that you can avoid unnecessary problems with taxes if you opt for a direct 401k rollover. This is a process in which the money is transferred from your existing account directly into a new IRA without ever leaving the banks. Since a check is never issued to you, taxes won’t ever be assessed. The money never technically leaves a qualified retirement plan, so the IRS doesn’t see a need to tax the money. On the other hand, if you use an indirect method to rollover your 401k, you could end up with problems.
When you do an indirect 401k rollover, a check is issued to you for about 80% of the total balance of your 401k account. The other 20% is held back for taxation purposes, as the money has technically left the qualified retirement account. After the check is issued, you have just 60 days to redeposit the total amount into a new, qualifying IRA account. Once this is done, the remaining 20% will then released into the new 401k rollover account. However, since there could be complications with this method of rollover, most people simply opt to perform a direct 401k rollover.
Something else to consider about rollover 401k IRA rules is the type of account that the money is going into. For example, if you’re doing a rollover from 401k to Roth IRA, you’ll need to withhold taxes. This is because the funds that are contributed to a Roth IRA account have already been taxed, while the 401k is funded with money that comes out before taxes. The upside to all of this is that the Roth IRA doesn’t require you to pay taxes when you withdraw money in retirement, as these taxes have already been paid.
If this initial tax burden is a problem for you, you’ll want to make sure that you do a 401k rollover into another tax-deferred IRA, like a traditional or an SEP IRA. This way, no money will be deducted for taxes, and your investment can continue to grow tax-deferred for your retirement.
However, be aware that recent 401k to IRA rollover rule changes in 2010 make this burden more manageable. For this year only, any taxes that come due as a result of a Roth IRA conversion can be broken up over the 2011 and 2012 tax years. If you anticipate being in a higher tax bracket upon retirement, it may be worth the time spent consulting with a financial advisor who can help you decide if a 401k rollover to Roth IRA is right for you.