Rollovers - From 401k to IRA

You have been laid off, fired, or quit your job.  You have done your research and you feel that after careful thought, you would like your 401k funds to be moved to an IRA.  Good choice.  

You will have many more options in an IRA.  You’ll have more control and, more than likely, a favorable fee structure.  You have asked around the town for referrals and you have decided to do a direct rollover.

Your new advisor asks questions about you, your goals, and your 401k plan.  Finally, she suggests a rollover of 401k funds.  

Generally, direct rollovers make a lot of sense.  This is because 401k rollover laws rules permit you to avoid receiving the 401k funds personally.  Instead, the assets are transferred directly to your IRA.

As a result, taxpayers avoid paying income tax 401k to IRA rollovers, and since you never received the money, you avoid a 20% withholding amount as well.  You’re on a roll!

As a bonus, when your 401k plan assets get transferred to the IRA, they continue their tax-deferred status.  In other words, a direct rollover is not normally a taxable event.

401k Withdrawal    

If, however, you choose to have your funds paid to you and not to an IRA, you may do so.

However, the plan provider will be required to withhold 20% of the amount distributed.  At the beginning of the following year you will receive a 1099 tax form detailing the amount distributed to you and the tax withheld.

If you are under the age of 59½, you may incur additional 10% 401k early withdrawal penalties as well.  

Partial 401k Rollover

Occasionally, I am asked about a partial 401k rollover.  An individual would like to rollover some (but not all) of their assets out of their 401k and into an IRA.

My response is always the same.  If you believe in theory that moving some of the assets is justified, why not move it all?  If it makes sense to move assets, it makes sense to move assets.  However, I can’t think of an example where a partial 401k rollover would make sense.

For the sake of simplicity, my suggestion is to either leave the money in your previous employer’s 401k, or perform a 401k to IRA rollover.  Don’t do a little of each.  Pick the method that works for you and stick with it.

Even if a partial 401k rollover were a good idea, many plan providers simply do not allow for it.

To summarize:

401k Rollovers

• Assets from 401k’s are rolled into an IRA directly.  You do not receive the assets directly.
• Thus, there are no federal income taxes due.  
• There are no federal income taxes withheld.  Your IRA receives 100% of the funds rolled over.

401k Distributions

• Assets from the 401k are paid to you directly.  You receive the money.
• Federal income taxes will be withheld by the plan provider at a rate of 20%.  You will receive 80% of the amount rolled over.
• Additional income taxes may be due the following year on your tax return.  The 20% withheld will be applied to your total tax bill.  Depending on your federal marginal tax rate, the final tax on the distribution may be more or less.

Partial 401k Rollovers

• May not be allowed by the plan provider.
• Does not contribute to simplicity of retirement accounts.
• Not recommended.