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

(Stefon Walters)

These days, it’s not often you see someone stay in the same job for their entire career. If you find yourself in a situation where you get a new job, and a new 401(k), but you don’t want to deal with multiple 401(k) plans in different places, you have the option of doing 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 main options: a direct rollover and an indirect rollover. With an indirect rollover, the money is 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 being rolled over; goes from your old plan to your new plan. In some cases, your old plan may write a check to your new plan’s provider for the amount transferred, and you’ll be responsible for forwarding it, but it’s still considered a direct transfer because the check was made payable to the new plan. and not 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 transferring, you can save yourself some effort by choosing to make a direct transfer.

2. Not following the 60-day rule

If you decide to do an indirect rollover, you absolutely must be aware of the 60-day rule, which states that you have 60 days from the date you receive the money from your old plan to either deposit it into your new plan or revert to it. deposit it. on 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 under 59½, you’ll also face a 10% early withdrawal penalty.

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

3. Ignore the tax implications

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

  1. You won’t owe any tax if you add $40,000 to the $160,000 you received and deposit the entire $200,000 into your new account.
  2. If you deposit the $160,000 and not the $40,000 withheld, the $160,000 will not be taxed, but you will 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 must 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 an expensive tax bill you didn’t expect.

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