What Is a Rollover
When you move money from one type of retirement account to a different type of retirement account, it is called a rollover. Whether you’re starting a new job or getting ready to retire, you’ll have to make a decision about your 401(k) funds. This is when you may want to consider a rollover.
There are two kinds of rollovers with different tax implications:
- A direct rollover is where your money is transferred directly from one retirement account to another. No money is withheld for taxes.
- An indirect rollover is where you withdraw the funds from your retirement account and a check is mailed to you. You have 60 calendar days to redeposit the funds into another qualified retirement account. If the check is not deposited by then, it is treated as an early distribution and subject to additional taxes and penalties.
Note: With indirect rollovers, employers typically withhold 20% of the amount that is pending transfer in order to pay the taxes due. This money is returned as a tax credit for the year when the rollover process is completed.
Differences Between Direct and Indirect Rollovers
| Direct Rollover | Indirect Rollover | |
| How Funds Get Transferred | The money is moved directly between accounts without its owner ever touching it. | You take possession of funds from one retirement account and personally reinvest the money into another retirement account—or back into the same one. |
| Penalties | The direct rollover protects your retirement funds from taxes and penalties. | To avoid penalties and taxes, the rollover must be effected within 60 days of withdrawing funds from the original account. |
| Time Frame |
The 60- day rule typically does not apply to direct rollovers. However, if you receive a check made payable to your new provider, it may expire after 180 days. |
You must reinvest the distribution into another tax-qualified account within 60 days to avoid taxes and penalties. |
Example of Direct Rollover
Let’s say that Bruce, who is 35 years old, started a new job at ABC company. Bruce decides he would like to rollover his funds from his previous employer’s plan to his new employer’s plan. He gets the rollover information for his new plan and begins a rollover request at his old plan. The rollover is processed and the funds are sent from his prior provider to his new provider in benefit of Bruce. The full amount of his account is rolled over between providers and no taxes are withheld.
Example of Indirect Rollover
Let’s say that Bruce, who is 35 years old, leaves his job at 123 company. He decides he wants to open an IRA and move his funds from his old provider to his new IRA. He does an indirect rollover for $10,000 and $2,000 of that is withheld for taxes. Bruce receives a check for $8,000. He has 60 days to redeposit the full $10,000 into his IRA to avoid additional tax and penalties. If he does so, the initial $2,000 that was withheld for taxes will be returned to him as a tax credit for the year the rollover process is completed. If he does not deposit the full $10,000 and only rolls over the $8,000 he received via check, the $2,000 that was withheld would be considered an early distribution subject to income taxes and a 10% penalty.
If you have any questions, please reach out to help@vestwell.com.