401k Rollover Rules

You have many options when you retire or change jobs and need to move the 401k you had with your past employer into your current 401k or a traditional or Roth IRA account. Your biggest consideration and the most important reason to know the 401k rollover rules is the potential tax consequences of the various types of 401k rollovers.

Your first option is to take a cash distribution. Because your 401k was funded with pre-tax dollars, taking a distribution makes the deferred taxes on your account balance come due. Also, because 401k funds are meant to be used for retirement, the IRS also imposes a 10% penalty if you're below age 59 1/2. An additional 20% of the balance will also be withheld as partial payment of the taxes due and, depending on your tax bracket, you could potentially owe additional taxes when you submit your tax return.

Next is the 401k indirect rollover. In this situation you receive a check for your account balance minus the same 10% penalty and 20% tax prepayment as in the cash distribution with one key difference. If you fund a qualified 401k or IRA account with the full balance (including the 30% that has been withheld) within 60 days of the distribution you qualify for a refund of the penalty and tax prepayment amounts.

Although you won't see this refund until you claim it as a credit when you file your taxes for the year of the distribution, you must fund your new account with the full balance of the 401k account you're rolling over. The need to come up with this additional 30% within 60 days makes the indirect rollover the least frequently utilized of the 401k rollover rules.

With a 401k direct rollover you don't receive your retirement funds in a check like the other two rollover options. Instead, you authorize the trustee of your 401k account to transfer the balance to a new qualified 401k or IRA account. You retain your entire retirement account balance and pay no taxes and incur no penalties with this trustee-to-trustee transfer making this type of 401k rollover the most popular.

(As with all 401k rollover rules and IRA rollover rules it's important to consult a qualified professional adviser before making any decisions regarding rolling over your retirement savings. )