A Profile Of The 401K Rollover Rules

Article Written By: RebbecaMyers

Compliance with the 401K rollover rules helps ensure individuals avoid negative tax implications. They must be followed when a person retires or changes jobs. There are several options available for rolling-over retirement savings funds that were accrued while working for a former employer.

One of the 401k rollover options is cash distribution. In this case, the account is closed-out and a check is made payable to the account-holder. Since distributions are classified as income, they are subject to federal and state taxes. An employer must retain 20 percent of the disbursement in order to cover the estimated income taxes. After a tax return is completed, the actual tax amount which is due could be lower or higher than 20 percent. The taxpayer is responsible for covering any excess fees. If taxes are below 20 percent, the taxpayer will receive a refund.

The other fees associated with a cash distribution payment is an early withdrawal penalty. It applies to any account-holder who is below the age of 59 1/2. The penalty usually amounts to 10 percent of the total disbursement.

Indirectly rolling-over is another option. This involves securing a cash distribution, and depositing it into an IRA with 60 days. Until the deposit is made, the employer is required to retain 20 percent for potential taxes. If the funds are not deposited within 60 days, they are subject to IRA penalties as well as income taxes. The deposit must equal the full amount, including the 20 percent which the employer withheld.

Directly rolling-over is the most convenient method for transferring funds from one plan to another without incurring taxes or penalties. Known as a trustee-to-trustee transfer, it involves funds which are deposited into an account directly by a bank. The account-holder must file documents detailing the amount to be deposited and the plan information. Acceptable plans include IRAs, 401Ks sponsored by another employer, or a parallel qualifying program.

For the worker who is at least 70 1/2 years old, there is another alternative. In addition to the above options, she or he may leave the funds with the employer, and begin receiving the required minimum distribution (RMD). Disbursements must be initiated on the first of April during the year after a person becomes 70 1/2 years old. The required distribution amount is based upon the account's previous year-end balance, and the age of the account-holder at the end of the year. It is calculated by dividing the December 31st balance by a life expectancy variable. All variables are specified in the Internal Revenue Service's Tables of Publication 590.

The IRS has developed three life expectancy tables. The Joint and Last Survivor Table is applicable to those whose sole beneficiaries are spouses who are at least 10 years younger. The Uniform Lifetime Table is applied to those whose spouses are not the sole beneficiaries, or who are not at least 10 years younger. The Single Life Expectancy Table is applicable to a beneficiary of the account.

The 401K rollover rules are well-defined. They regulate the transfer of all funds from retirement accounts. The government assumes all these transactions are direct disbursements, and subject to taxes, unless account-holders file documents to prove otherwise.

About the Author

A more comprehensive look at 401k rollover rules and 401k rollover options can be found at the financial planning site.

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