3 Things to Know Before Rolling Over a Retirement Account

As some people go through their careers and switch companies from time to time, they may find that they have several 401(k) plans or other retirement accounts. If you decide that you don’t want to deal with multiple plans, you can roll over your old plan(s) into your new plan, making it much easier to manage and keep up with.

If you’re thinking about doing a rollover, here are three things to know beforehand.

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1. The type of rollover you want to do

When doing a rollover, you can choose between a direct rollover or an indirect rollover. In a direct rollover, your previous plan provider sends your money directly to your new plan provider without you ever touching it. In some cases, if a plan-to-plan transfer can’t be directly made, your old plan provider will write out a check in your new plan provider’s name but give it to you to deposit it into the new account. Although you possessed the money, it wasn’t in your name, so it’s still considered a direct rollover.

With an indirect rollover, your old plan sends you the money, and it’s your responsibility to make sure it gets to your new account. The IRS gives you a 60-day grace period to deposit the funds into your new plan or redeposit it back into your old account. In most cases, it’s easier to do a direct rollover, but there may be times when it’s beneficial to be able to access your funds in the period between it switching accounts.

2. Money may be withheld

If you’re doing an indirect rollover, your old plan provider will typically withhold 20% of the total amount for tax purposes. So if you’re rolling over $100,000, you’ll technically only receive $80,000. You’ll also be responsible for making up the withheld amount when you move your money over into your plan.

In this scenario, if you add the $20,000 back and redeposit the whole $100,000, you won’t owe any taxes, and you’ll get the withheld $20,000 back in a tax refund when you file your return for the year. If you deposit everything except the $20,000 withheld, you’ll owe taxes on that amount and potentially face a 10% early withdrawal penalty. If no money is deposited within the 60-day window, the whole $100,000 will be counted as taxable income, and the $20,000 withheld will be counted as taxes paid.

3. You can potentially spark a tax bill with a Roth conversion

Retirement accounts like a 401(k) or traditional IRA are pre-tax accounts. With a 401(k), the money is taken out of your account before you even receive your paycheck. Contributions to a traditional IRA are technically after-tax, but you can possibly deduct your contributions, so it’s labeled pre-tax since your tax break is on the front end. On the other hand, a Roth IRA is a post-tax account; you make after-tax contributions and receive your tax break on the back end.

If you’re rolling money over from a 401(k) or traditional IRA to a Roth IRA, then you’ll likely owe taxes on the amount rolled over. Typically, the money in your 401(k) hasn’t had taxes paid on it yet. When you convert that money to a Roth, then the IRS takes that opportunity to get its cut.

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