Avoid These 3 Critical Mistakes During a 401(k) Rollover | Personal Finance

(Stefon Walters)

Nowadays, it’s not often that you see someone stick with the same job for the entirety of their career. If you find yourself in a situation where you get a new job — and a new 401(k) plan — but don’t want to have to deal with multiple 401(k) plans in different spots, you have the option to give a 401(k) rollover.

Rolling over your 401(k) has its benefits, but it can also have drawbacks if you’re not completely familiar with how it works. Here are three critical mistakes to avoid when doing a 401(k) rollover.

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1. Doing an indirect rollover for no reason

When you decide to do a 401(k) rollover, you have two primary options: a direct rollover and an indirect rollover. With an indirect rollover, the money gets paid to you, and then it’s up to you to take it and put it into a rollover IRA within the required period as defined below.

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With a direct rollover, you don’t touch the money that’s being rolled over; it goes from your old plan to your new plan. In some cases, your old plan may write a check to your new plan provider for the rolled-over amount, and you’ll be responsible for forwarding it, but it’s still considered a direct rollover because the check was written out to the new plan and not to you.

Doing a direct rollover can take some of the legwork out of rolling over funds. If you don’t need to access the funds you’re rolling over, you can save yourself some effort by electing to do a direct rollover.

2. Not following the 60-day rule

If you decide to do an indirect rollover, you absolutely need to be aware of the 60-day rule, which states you have 60 days from the date you receive the money from your old plan to deposit it into your new plan or redeposit it back into your old plan. If, for whatever reason, you don’t deposit the money within 60 days, the IRS will treat it as a withdrawal, and you’ll have to pay income taxes on the full amount. If you’re younger than 59 1/2, you’ll also face a 10% early withdrawal penalty.

Not following the 60-day rule can be a costly mistake.

3. Not knowing the tax implications

If you decide to do an indirect rollover, the IRS requires that your old plan provider automatically withhold 20% of the total amount you’re rolling over. So, if you’re transferring $200,000, you’ll only receive $160,000. And, to add insult to injury, you’ll be responsible for making up the withheld amount when you deposit the money into your new plan. Here are the three tax implications you can face when doing an indirect rollover:

  1. You won’t owe any taxes if you add $40,000 to the $160,000 you received and deposit the full $200,000 to your new account.
  2. If you deposit the $160,000 and not the $40,000 withheld, the $160,000 will be nontaxable, but you’ll owe taxes on the $40,000 and possibly face the 10% early withdrawal penalty.
  3. If you don’t redeposit any of the $200,000 within the 60-day grace period, you’ll have to report the $200,000 as taxable income and the $40,000 withheld as taxes paid.

Not knowing the tax implications of an indirect rollover can result in a costly tax bill you weren’t expecting.

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