Rolling your 401(k) – Trustee to Trustee Direct Rollover, Modified Adjusted Gross Income (MAGI) Income Limits for Deductible Contributions to a Traditional IRA

(July 29th, 2009)

When you leave your current job, you will have to most likely fill out the 401(k) distribution election form. The most logical thing to do with your 401(k) from a taxation perspective is to do a direct rollover (also known as a trustee-to-trustee transfer) of your money. With this type of rollover, the money goes directly from your 401k plan into another tax-deferred account, either an Individual Retirement Account (IRA) or your new employer’s 401(k) plan, 403(b) plan or 457 plan. 403(b) plans are generally for teachers, educators and non-profit employees while 457 plans are offered by local state governments. With a direct 401k rollover, you do not have to pay any taxes on the money when it comes out of your old employer’s 401(k). The money will also continue to grow tax-deferred in the new account. In other cases, instead of transferring the money directly to the new 401k plan or IRA, your employer might give you a check for the 401(k) balance.

Rollover 401k Video - Options Available for a 401k Rollover to an IRA or Rollover to New Employer

 
This video explained by a pretty lady shows you the options you have when you are changing jobs when you can either take your money with you and roll it over to an IRA, or rollover to your new employer's 401k plan.

With a direct rollover, the check will be made out to the financial institution that holds and maintains your account. We advise NOT to instruct your old employer to make the check out in your name, as the tax consequences and penalties for doing this are severe! Here’s how. If the check is made payable to you, your former employer will be required to withhold 20% of your account value as federal withholding tax.

Note: The IRS is very strict on this 60 day distribution rule and there are no exceptions.

The size of your 401(k) account also matters. For instance, if your account balance is less than $5,000, you may be forced to take the money out of your employer’s 401(k) plan when you quit or leave. If it’s more than $1000 and less than $5,000, and you don’t tell your employer what you want to do with the money, your employer can automatically roll the money in to an IRA on your behalf. If the balance is $1000 or less, your employer will simply issue you a check for this full amount. You should let your employer know right away that you want to do a rollover if your balance is less than $1,000.

If your 401(k) account balance is $5,000 or more, and you have not reached your normal retirement age (65), your employer is required to let you leave your money in the 401(k) plan if you choose to. This might be a good temporary choice, but you have to make a permanent decision.

Rollover 401k Video - IRA Rollover and its Pros and Cons

 
This video by Christy Lee who is a licensed stockbroker gives you a run down on the options you have when you rollover to an IRA from your old employer's 401k.

Rolling to a Traditional IRA

If you choose to rollover your 401(k) account to a traditional IRA, you can make two types of contributions, i) a deductible contribution where you can deduct from your income tax and ii) a non-deductible contribution where you can’t deduct your contributions from your income tax. The advantage of rolling to a deductible traditional IRA is that you can deduct your contributions from your income tax now. However, if you rollover to a non-deductible traditional IRA, you will not be able to deduct your contributions from your income tax now. However, there is always a reverse side. With a deductible IRA, you will have to pay income tax when you withdraw the funds upon retirement, typically at the age of 65.

The deductible IRA seems like a better deal because you can get an extra tax break of being able to deduct your contributions from your income tax. However, there is a catch here. The catch is that if you have a 401(k) or any other employer sponsored tax-qualified plan, you can deduct contributions to your traditional IRA only if your income is below the Modified Adjusted Gross Income (MAGI) limits.