A Direct IRA Rollover is when your
401k retirement savings (or 401k distributions) are transferred
directly from your old employer's account to your own
Individual Retirement Account through a trustee-to-trustee
transfer. This means the money never actually reaches
your hands, it is wired from your old 401k administrator
to your new one. With this method, no taxes are withheld
and you will NOT have to pay any penalties
If you own your employer's company
stock as part of your retirement savings portfolio, you
have 2 options available:
-
You can transfer
your company's stock directly to your IRA Rollover Account
without liquidating the stocks
- You can sell the stocks at current
market prices and rollover the cash to your IRA Rollover
Account. You will NOT have to pay any taxes on this, provided
you do the rollover WITHIN 60 days.
If you take the cash from your old
employer administered 401k plan instead of rolling it over
to a Rollover IRA, you will have to pay early withdrawal
penalties (10%) and a 20% tax withholding fee. For example,
consider this scenario:
| You Receive
401k Cash Distribution |
=
$100,000 |
| 20% Required Withholding
Tax |
=
$(20,000) |
| Your Check in the Mail |
=
$80,000 |
| 10% Early Withdrawal
Penalty Fee |
=
$(10,000) |
| Federal Income Tax Extra
of 10% |
=
$(10,000) |
| 7% Local State Income
Tax |
=
$(7,000) |
| You Receive |
=
$53,000 |
* The above example assumes the 401k
retiree is less than 59 and 1/2 years old and has to pay
the 10% Early-Withdrawal Penalty fee. However, if you are
older than 59 and 1/2, this 10% early-withdrawal penalty
fee does NOT apply to you. The above example also assumes
a Local State Tax rate of 7% (varies from state to state)
and a Federal Tax Rate of 30% (20% Withholding Tax + 10%
Federal Income Tax)
If you change your job or officially
retire, the total 401k Retirement Savings you receive could
be less than you expect. This is because companies by law
are required to withhold 20% of your entire 401k savings
account for tax purposes. This applies only to qualified
retirement plans and includes 401k
plans, 403b plans and other
profit sharing plans.
This law is implemented to discourage
retirees from withdrawing money from their plans early on
and let it earn the power of compounding interest. This
20% IRA Withholding law can be overridden by doing a 100%
Direct IRA Rollover to your own Individual Retirement
Account (IRA).
The 20% Withholding Law does NOT apply
to:
- Individual Retirement Accounts (IRAs)
- SEP-IRA
- SARSEP-IRA
- If you quit your current job with
no intention of returning (aka "Separation from Service")
during or after the age of 55, you are allowed to make withdrawals
from your retirement savings account without paying the
10% early withdrawal penalty. Read your 401k Summary document
to determine whether you are allowed to make any withdrawals
in the course of your employment contract. Most employers
do not allow employees to withdraw money from their 401k
plans during their working life.
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