You might be surprised to find out that the rollover 401k plan, as one of the older retirement account options, is subject to a greater number of IRS regulations than some of the newer retirement account options that have been developed recently. For this reason, it makes sense to reevaluate your 401k retirement holdings and acquaint you with some of the newer retirement savings vehicles available today.
Rollover options are broken down into two general categories, regardless of the type of account you plan to roll your 401k funds over into – indirect and direct. For tax reasons, you’ll probably want to avoid the former category and choose the later. In order to do that, however, there’s one thing that you must first consider.
While it may seem overly simplistic, the first qualification you must have before choosing to do a 401k rollover is that you must have an account established that can receive the funds. This doesn’t mean that you have an account offered to you by a new employer, or that you have the intention of opening a new account. The new account must be active and mature enough – depending on the rules of your new employer and the IRS – that it’s eligible to receive the funds from your former 401k account.
This is a very easy distinction to overlook, and if you request a rollover that cannot be completed, the 401k funds will be sent back to you as a check. In this situation, you’ll then become liable for any withholding, penalties and taxes you’re subject to under IRS statutes. You can avoid this mistake by making a simple phone call to the manager of the new account or fund and confirming its status.
In a direct rollover, the funds move directly from your old 401k account into your new IRA account. This is a transaction that takes place in different ways (depending on how the fund managers determine is best), but all direct 401k rollovers have one key quality in common – you never see or receive any of the money at the time of the rollover. This is the best type of rollover because there is minimal work on your part and minimal risk of becoming responsible for taxes or other penalties.
The other type of 401k account rollover is called an indirect rollover. This type of rollover means more work for you and opens you up to the risk of taxes and penalties if you don’t complete the rollover properly within a very limited and specific interval of time as determined by the IRS. Even with adherence to the time interval (usually 60 days), it’s still likely that 20 percent of the money you receive from your 401k will be withheld for the IRS. Depending on how much money you have invested, this can represent a substantial loss – one that can be entirely avoided by properly requesting a direct 401k rollover.
One other consideration you should make when evaluating your 401k rollover options is that you don’t necessarily have to rollover your money. If your 401k account is performing well and still meeting your short and long term retirement savings goals, it may be to your advantage to leave your money in the old 401k plan. However, most employees will benefit from the additional investment options and higher rates of return offered by 401k to IRA rollovers. A good financial adviser can look at your 401k as a part of your overall retirement savings strategy and help you determine the best option for rolling over your account.