Why you should reconsider an indirect 401(k) | . extension Smart Change: Personal Finance

Rollover occurs when you transfer money from one 401(k) plan to another. There are two options when doing an extension, but that’s why indirect extension should be reconsidered.

You may find yourself in a situation where you prefer to handle the transfer yourself, which is known as indirect pass. With an indirect rollover, your old plan provider will liquidate the assets in your plan and then send the money to be deposited into your new account. When you make an indirect rollover, you have 60 days from the date you received the funds to deposit them into your new plan (or re-deposit them into your old account).

If you don’t deposit the funds within 60 days, it will be considered a withdrawal, and you will owe income taxes on the entire amount. Persons under the age of 59 1/2 will also incur an early withdrawal penalty of 10%. Depending on how much you are behind, failure to follow the 60-day rule could result in you indebting a large amount. Regardless of income taxes owed, the early withdrawal fee of 10% alone would be $10,000 on $100,000.

When your 401(k) plan provider sends you money, the IRS requires that you automatically withhold 20% of the total amount. So, if you are transferring $100,000, you will only receive $80,000. To make it worse, you will also have to make up the amount withheld when you deposit money into your new plan. Here are the three tax scenarios you can find yourself in when doing an indirect rollover:

1. You will not owe any taxes if you add $20,000 to the $80,000 you received and deposit the entire $100,000 into your new account.
2. If you deposit $80,000 and not $20,000 withheld, the $80,000 will be non-taxable, but you will owe taxes on the $20,000 (and potentially face a 10% early withdrawal penalty).
3. If you do not re-deposit any of the $100,000 within the 60-day period, you will have to report $100,000 as taxable income and $20,000 withheld as taxes paid.

With live rollover, you do not touch the funds while they are being transferred; It moves from one plan to the next without having to do much work. There may be a case where your old plan provider can’t make a plan-to-plan conversion, so they will write a check in the name of your new plan and ask you to forward it to them, but this still counts as a direct extension because you never “owned” the money – the check was written to your provider Your new plan.

Some people do indirect rollovers because they want to be able to use the funds in the 60-day grace period, but if your goal is just to move money from one account to another, it is better to do a live rollover. You don’t have to worry about missing the 60-day window, there’s less chance of something going wrong.

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