| Indirect 401(k) Rollovers
– Short Term Cash Source, IRS Penalties, Important Notes to
Consider
(August 14th, 2009)
IRA
Rollover Related Information
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Indirect rollovers work in reverse of direct
rollovers where the check is made out to the financial institution
that holds and maintains your 401(k) retirement account (this is
also known as a direct trustee to trustee transfer). In cases of
indirect rollovers, a check will be made out to your name, instead
of your financial institution and 20% of it will be withheld for
payment to the Internal Revenue Service. Once you receive the check
in your hand, you will have 60 days to deposit the face value of
the check to an Individual Retirement Account at wherever your financial
institution is, examples include Fidelity, Morningstar or your local
bank. If you complete the rollover within the 60 day limit, you
will not be taxed and will be able to continue investing salary
deferrals in to your IRA.
For
instance, if you have $100,000 in your 401(k) that is made
payable to you in a check, your employer will withhold $20,000
for remittance to the government. Thus, in order to bring
your balance up to $100,000 in your new account, you will
have to pay from your own pocket, an additional $20,000 within
60 days of receiving the distribution. The IRS will then return
the $20,000 owed to you when you file your tax return upon
correct completion of your rollover. |
An indirect rollover can be useful if you require
some cash as a short term loan (remember the 60 day limit). However
it can be very dangerous if you use up the entire loan balance and
cannot repay within 60 days, this could be a total financial disaster!
Why would anyone use 60 a 401(k) rollover as a source of short term
cash? Well useful examples include if you need cash to close the
sale on a new house while you are in the middle of closing the sale
on your old house. If you cannot repay back the loan within 60 days,
you will be charged income taxes on your withdrawal and a 10% early
withdrawal penalty/fee.
Also note that if you deposit some or all 20%
of funds that were withheld by the IRS, you will receive a refund
of this 20% from the IRS when you file taxes for the year. If you
fail to pay this 20% in to your IRS, it will be considered a cash
distribution and will be subject to taxes & penalties. Also
once you exceed a certain time period, you will not be allowed to
contribute the 20% back to your IRA and defer it from taxes.
Important Notes
i) You can only do one tax-free and penalty-free
indirect IRA rollover in a calendar year; although you can do as
many direct rollovers as you like.
ii) You can avoid the 20% withholding by the
IRS using a two-step process. Step 1 involves setting up a direct
rollover to an IRA and Step 2 is to do an indirect rollover to another
IRA, this will give you temporary use of the money for 60 days.
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