How to Make The Most of Your Rollover

If you participated in a former employer’s retirement plan, you don’t have to leave your retirement savings with your former employer, you can take it with you. You can either request a distribution and take the cash – which will cost you a lot in taxes and future retirement savings – or you can keep growing your savings for retirement by making a rollover to a new employer’s plan or an IRA. A self-directed IRA can open the door to a broad menu of investment options, including alternative investments such as real estate. Once you decide where you want to invest your savings, be sure you understand the best way to move your money to its new location. IRS tax laws treat a “direct” and an “indirect” rollover differently, and you could end up with an unexpected tax bill if you don’t know the difference.

The following hypothetical example walks through the two methods for rolling over assets from a former employer’s retirement plan to an IRA.

Roy, age 37, left his employer after 10 years to work for a new company. Roy has been dutifully deferring some of his salary into a 401(k) plan since he started working for his former employer and has accumulated $75,000 in his 401(k) account. Roy knows that he should keep investing and growing his nest egg for retirement. So, Roy decides to roll over his pre-tax 401(k) savings to a self-directed Traditional IRA. Roy consults with his financial advisor to explore his options for moving his money to an IRA.
Option 1: Indirect rollover
Roy can request that his former employer’s 401(k) plan pay out his $75,000 account balance by mailing a check to Roy or sending the dollars to Roy’s checking account. Roy then has 60 days from the day he receives the money to complete the rollover to the IRA.

Because Roy could spend the money if he chooses, the tax laws require the plan to withhold 20% of the gross distribution amount and send it to the IRS as prepayment of the income taxes due on the distribution. This means that Roy will receive a check for only 80% ($60,000) of the total distribution of his 401(k) account. The other 20% ($15,000) is sent to the IRS by the 401(k) plan trustee.

Any amount Roy deposits into an IRA within 60 days will not be taxable to him (until he withdraws it from the IRA). To avoid being taxed on the $15,000 withheld and sent to the IRS, Roy must come up with $15,000 from another source to deposit into the IRA so he can complete a rollover of the full amount distributed from the 401(k) plan ($75,000). If he does this, Roy may receive a refund of some or all of the 20% withholding amount when he files his federal income taxes for the year.

If Roy does not have an extra $15,000 to make up for the amount that was withheld, Roy will have to include an extra $15,000 in his taxable income for the year. And, because Roy is younger than age 59½, unless he meets an exception to the early distribution tax, he will also owe an additional 10% tax on the $15,000 ($1,500).

Option 2: Direct rollover
Roy can request that his former employer directly roll over his 401(k) account balance to a self-directed IRA. When the assets are moved directly from the plan trust to the self-directed IRA custodian in a direct rollover,

•  Roy will not have access to the money,

•  There is no income tax withholding, and

•  100% of the gross distribution will be rolled over.

Roy will not have any tax consequences and his retirement savings will continue to grow tax-deferred in his IRA until he chooses to withdraw them (ideally, not until he retires).

strata-faviconFrequently Asked Rollover Questions.

Congress created these complex tax rules to discourage individuals from using the indirect 60-day rollover option because there is a temptation for individuals to spend their retirement savings before retirement. Many people are not aware of how the withholding rules impact their tax liability and rollover options. If you have money in a former employer’s plan, be sure to seek advice from your tax professional before asking for a distribution.

If you have questions about rollovers, you may also contact us at 866-928-9394 or

Tags: IRA, IRA tax laws, IRS Reporting, IRS Rules, self-directed ira, tax strategy, taxation