- Direct
rollovers allow avoidance of 20 percent tax withholding
-
- If
you expect to receive a distribution from your employer’s pension,
profit sharing or 401(k) plan, there is some important information
you should know.
- Without
understanding lump sum retirement plan distributions, you might have
to hand a portion of your hard-earned retirement money in
unnecessary taxes and penalties to the IRS.
- Your
employer is required by law to automatically withhold 20 percent of
the distributions unless you elect to roll over your distribution
directly into an eligible retirement plan, such as a traditional
individual retirement account (IRA) or a new employer’s plan.
The law impacts almost all distributions, including those due
to termination of employment.
-
- Distributions made payable
- Generally,
a plan distribution that is paid directly to you may be subject to
the 20 percent tax withholding.
This means that you would take home only 80 percent of your
total plan distribution. The
20 percent withheld would be sent to the IRS and credited toward
your federal income taxes. Furthermore,
if you take a distribution before age 591/2, you may be subject to
an additional 10 percent tax penalty for an early withdrawal.
-
After you receive your
distribution, if you decide that you would like to roll it over into
another retirement plan, the following options are available:
-
You may roll over the 80
percent that you received within 60 days.
The remaining 20 percent withheld would be considered taxable
income.
-
You may roll over 100
percent of the amount of the distribution within 60 days by coming
up with cash to replace the 20 percent withheld which would be
credited toward your current years tax liability.
-
But it’s easier to just
avoid the 20 percent tax withholding by arranging for a direct
rollover with your employer.
-
Rather than receiving the
distribution directly, you have the option to elect to have all or
part of your eligible distribution rolled over from your company’s
retirement plan to a traditional IRA, or to your new employer’s
plan.
-
A rollover IRA, or conduit
IRA, is established for the sole purpose of receiving an eligible
distribution from a qualified plan.
A rollover IRA is designed so that you can subsequently roll
the money over into a new employer’s qualified retirement plan.
You can, of course, leave the money in the rollover IRA and
continue to benefit from tax-deferred growth and the wide range of
investment choices typically available.
-
If, however, you wish to
maintain the option of being able to eventually roll the assets into
a new employer’s plan, you may not make additional IRA
contributions to the rollover IRA.
-
The rollover IRA must hold
only those assets received from a former employer’s qualified
retirement plan as well as the gains and earnings on those assets.
You would need to establish a separate IRA, commonly referred
to as a contributory IRA, to make your annual contributions of as much
as $2,000.
