Do’s & Don’ts of 401k Rollovers

Chances are you’ll have to roll over a retirement account at least once in your life. Most likely, it will be when you leave your current employer and take your 401(k) with you. Or, you may be eligible to roll over your current IRA into a Roth IRA. So here’s a tip today.  Roll over your 401k account into an IRA account.  This will give you many more investment options than either leaving the money in your old 401(k) or rolling it over into your new employer’s plan. By the way, each of those options is available at the discretion of the employer.

If you ask your company, they’ll be only too happy to send you a check for the full vested balance of your account.  But if the company makes the check out to you, they are required withhold 20% for taxes. And you’ll get hosed big-time. That leaves you between a rock and a hard place. So be warned.  You’ll have to come up with the missing 20%, or pay income taxes (plus a 10% penalty on the withdrawal if you are under age 55). And worst yet, you won’t get the withheld money back until you file your taxes next April.  So never have your employer make out your 401k account to you in the form of a check.  Never, ever, ever do that, okay? Rollover the money via direct transfer. NEVER get a check made out to yourself.

You know, a recent tax court decision answered a long-standing question about IRA rollovers. If you take cash from a qualified retirement plan account, you must rollover cash into your IRA, rather than some other asset of equal value.  Ditto if you are simply rolling funds from one IRA to another. You cannot, for example, do what the poor guy in the court case did – he used cash withdrawn from a retirement plan or IRA account to buy stock and then he attempted to roll over the shares of stock. Nice move buddy, but NO CAN DO.  If you try this type of maneuver, the door is shut on any rollover and you’ll be taxed on the withdrawal. Plus if you’re not 59 1/2, you’ll generally owe the 10% premature withdrawal penalty tax.

Remember, if you are simply transferring retirement funds from one IRA to another, as in a rollover to a Roth IRA, there is no 20% withholding tax to worry about. I addressed that earlier this week.  So a withdrawal check can be made out in your name with no adverse tax consequences… but here’s the kicker… as long as the other IRA has not received any other rollovers within the last 365 days.  However, you must still get the money into the other IRA within 60 days, or you will be taxed on the withdrawal. If you’re confused by all of this, get the advise of a qualified retirement expert, including a Financial Planner or tax advisor.   I typically never advise my clients or radio listeners to have any checks made out to them. You’re much better off and safer having the rollover monies made payable to the custodian – that is, the new company that you’ll hold your IRA with. For example, like Fidelity, or Schwab or Vanguard.

Every so often you may face a temporary cash crunch when you desperately need some extra dough — but just for a short time.  A last ditch potential solution is “borrowing” from your IRA account — which can be done with virtually zero paperwork, no delays from balky loan officers, and no interest charge.  You simply withdraw the needed funds and make sure you then replace the money within 60 days. Again, that’s 60 days!  Not a day later.  If you do this, you’re considered to have made a tax-free IRA rollover.  The money can be deposited back into the same IRA account it came from or into a different account, but each account can receive only one of these rollover deposits during any 365-day period.  I don’t recommend you do this, but I wanted to at least cover it because I do get questions on it from my radio listeners.