By Stephan Scribner
If you’re asking this question, you probably have a 401(k) or other retirement plan through a former employer. The short answer is yes—most retirement plans allow you to roll your plan funds over into an IRA after you’ve left your employer’s service. However, there is more than one way to do a rollover, and how you do it can be critical.
In most cases, your best strategy is to do a direct rollover. This is a direct transfer of funds from your employer-sponsored plan to your IRA. The administrator of your employer-sponsored plan may send the check right to the trustee of the IRA you have selected. That way, the money never passes through your hands.
Alternatively, the plan administrator may give the check to you to deliver to the IRA trustee. This also qualifies as a direct rollover as long as the check isn’t made payable to you. Instead, it should be made payable to the IRA trustee for your benefit. A direct rollover will avoid tax consequences and penalties.
You can also do an indirect rollover, but it’s rarely a good idea. Here, the check is made payable to you. When you receive the check, you cash it and deposit the funds in the new IRA within 60 days.
The big drawback: Before releasing your plan funds to you, the plan administrator is required to withhold 20 percent of the taxable amount for federal income tax. To make sure you deposit the correct amount, you must replace this 20 percent out of your own pocket. However, if you properly follow all the IRS rules for rollovers, you will avoid tax consequences and can get back the amount withheld for taxes when you file your annual income tax return.
You can roll your distribution into either a traditional IRA or Roth IRA. If you roll the funds over into a Roth IRA (often called a “conversion”) you’ll include the taxable portion of the distribution in your taxable income in the year you roll the funds over. (A distribution from your retirement plan’s Roth account can only be rolled over into a Roth IRA.)
You may not be allowed to roll over certain types of retirement plan distributions into an IRA. Further, when considering a rollover, to either an IRA or to another employer’s retirement plan, you should consider carefully the investment options, fees and expenses, services, ability to make penalty-free withdrawals, degree of creditor protection, and distribution requirements associated with each option. Consult a tax professional for details.
Scribner is an Infinex financial consultant with BSNB Financial Services.