401(k) Direct RolloversPosted on September 23rd, 2010 William No comments
A direct IRA rollover is when you move your retirement savings from your 401(k) directly to your IRA from the old account, through a trustee to trustee transfer. When you're rolling over a 401(k) to an IRA you always want to make it a direct rollover, as this avoids having to pay taxes or penalties; if you ever handle the money, you can trigger early withdrawal penalties that, combined with taxes, can wipe out half of your savings. The other type of rollover is, surprisingly enough, called an indirect rollover; when you do an indirect rollover, you get a check written out to you (with 20% of your IRA withheld) and you have 60 days to get that money deposited into an appropriate retirement account before triggering the aforementioned penalties. If for some reason you do an indirect rollover, you'll need to make up that 20% with other funds (it's held to pay taxes if needed) in order to avoid taxes on the part not rolled over.
Generally, when you're holding stock in your 401(k), you have two options. You can transfer the stock directly to your IRA, or sell it and transfer the cash to your IRA; in the latter case, you need to make sure that the sale occurs within 60 days of the rollover to avoid paying taxes.
While you would normally move your money into a traditional IRA or a rollover IRA, it is also possible to move it into a Roth IRA. In this case, you must pay taxes on the money (because the account was funded with pretax dollars) but you do not need to pay the early distribution penalties and taxes, provided you do not withdraw the money for at least five years. Obviously, when doing this you want to have cash on hand to pay the taxes, so that they don't reduce your retirement savings. This is essentially one way of getting around the $5000/year limit on Roth IRA contributions. (This limit will rise with inflation after 2010, and is also higher for people over 50).
Note: there are special rules for members of the military; see IRS Publication 3, Armed Forces' Tax Guide for details.
You can check the IRS Rollover Chart to see whether you can do a rollover between two accounts.