What is a 401(k) Rollover?

If you’ve had a 401(k) at all then you’ve probably come across the term “rollover” in the past.

You may have even been told or recommended to “rollover” a 401(k) or other account.

But still, you’re probably left with these questions:

• What exactly does a rollover mean?

• What do I need to know about them?

• How does it impact me?

Let’s dive in.

Rollover Defined

A rollover is the process of transferring, or “rolling over”, an eligible retirement plan/account to another.

The most common rollovers are from employer qualified retirement plans, such as 401(k)s, to other employer qualified retirement plans (if allowed by the plan) or individual retirement arrangements (IRAs).

Direct vs Indirect Rollovers

Logistically, there are two methods of conducting a rollover: direct and indirect.

It’s imperative to know the difference because it could be costly if not.

Direct Rollover

A direct rollover is the process where your qualified plan funds are “directly” transferred from one trustee to another WITHOUT your direct involvement. The sending trustee will issue a check, or wire your funds, directly to the new and receiving trustee.

In this process, your funds shouldn’t enter your direct possession (e.g. check received, bank account deposit, etc.).

However, if the transaction isn’t completed with 60 days then the funds will be treated as an early distribution and become taxable.

Outside of failing to properly roll over your funds, direct rollovers aren’t taxable UNLESS you’re converting pre-tax (Traditional) money to after-tax (Roth) money in the process. For example, you may opt to rollover a small 401(k) that is all pre-tax money to your Roth IRA. This would would be a taxable event.

It’s important to know that you WILL receive a 1099-R tax form with with code G designated for a trustee-to-trustee direct rollover of an employer qualified plan to an IRA. Distribution Code G simply notates that your rollover was a trustee-to-trustee direct rollover and that no portion should be taxable.

Indirect Rollover

An indirect rollover is a similar process as a direct rollover EXCEPT that you receive the funds directly and are responsible for depositing the funds into a qualified account within 60 days or you’ll have to pay an early withdrawal penalty, income taxes, and potentially taxes on excess contributions.

Also, with indirect rollovers you generally have 20% of the amount withheld for taxes, if rolling over an employer qualified plan, but it’s returned as a tax credit for the year the rollover is completed. HOWEVER, you’re still responsible for depositing the full amount into your new account or that 20% will be deemed an early distribution and you’ll have to pay a 10% early withdrawal penalty along with income taxes.

Example

Let’s say you have a $20,000 401(k) that you’re indirectly rolling over. You receive a check for $16,000, that you deposit into your checking account, because $4,000 has been withheld for taxes. You’re still responsible for depositing $20,000 into your new account. If not, that $4,000 will be taxable and assessed a 10% early withdrawal penalty. The $16,000 would be considered a nontaxable distribution in which no taxes or penalties would be owed.

Finally, you can only complete 1 indirect rollover every 12 months and it must be from one account to another account (i.e. you can’t split between multiple accounts or it’ll be considered 2 indirect rollovers).

As you can see, this method extremely discouraged, when direct rollovers are possible, simply because of the potential costs and issues.

How to Initiate a Rollover

Now that you know what a rollover is and the types of rollovers you may be wondering how to actually initiate a rollover. Initiating a rollover always starts with contacting the administrator that manages your 401(k). The easiest route is pulling the client service number off of your 401(k) statement and calling that number. From there, the associate should be able to guide you through the process to get your rollover initiating.

Finally, once a rollover is complete you will still need to make sure the funds get invested! If not, you’ll miss out on the growth that your investments could be doing.

Now you know the basics about rollovers and how they work. So the next time you need to do a rollover, direct or indirect (but hopefully direct), you can feel confident in what to do and how to go about doing it!