As people switch companies, they may end up with multiple 401(k)s or retirement accounts. If you don’t want to manage multiple plans, you can roll your old plan(s) into your new plan.
If you’re considering a rollover, know these three things.
You can do a direct or indirect rollover. Your old plan provider sends your money directly to your new plan provider in a direct rollover.
Occasionally, if a plan-to-plan transfer can’t be made directly, your old plan provider will write you a check in your new plan provider’s name. Although you had the money, it wasn’t in your name, so it’s a direct rollover.
With an indirect rollover, your old plan sends you the money and you transfer it to your new account.
IRS gives you 60 days to deposit funds into your new plan or old account. In most cases, it’s easier to do a direct rollover, but it may be beneficial to access your funds during the transition.
If you do an indirect rollover, your old plan provider will withhold 20% for tax purposes. If you roll over $100,000, you’ll get $80,000. You must make up the withheld amount when you transfer money into your plan.
If you add the $20,000 back and redeposit the whole $100,000, you won’t owe any taxes and will get the withheld $20,000 back as a tax refund.
If you deposit all but the $20,000 withheld, you’ll owe taxes and face a 10% early withdrawal penalty. If no money is deposited within 60 days, the entire $100,000 is taxable income, and the $20,000 withheld is taxed.
Roth conversions can cause tax bills.
401(k)s and IRAs are pre-tax accounts. With a 401(k), money is deducted before your paycheck.
Traditional IRA contributions are technically after-tax, but you can deduct them, so it’s labelled pre-tax. A Roth IRA is post-tax; you make after-tax contributions and receive a tax break later.
If you roll a 401(k) or traditional IRA into a Roth IRA, you’ll likely owe taxes. 401(k) money isn’t taxed yet. When you convert to a Roth, the IRS gets a cut.
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You will not owe any taxes and will receive the withheld $20,000 as a tax refund if you add the $20,000 back and redeposit the entire $100,000.
You’ll owe taxes and suffer a 10% early withdrawal penalty if you deposit everything except the $20,000 withheld. If no funds are deposited within 60 days, the entire $100,000 becomes taxable income, as well as the $20,000 withheld.
Tax bills may result from Roth conversions.
Pre-tax accounts include 401(k)s and IRAs. Money is deducted from your 401(k) before you get paid.
