401 K Rollover Rules

401 K rollover rules are basically simple, although it does involve what may seem like excess paperwork. A 401K rollover is basically taking money from your 401K account and transferring it (i.e. rolling it over) to a new account somewhere else. The new account can be either a IRA account or 401K account. The best reason for taking advantage of the 401k rollover benefits rules is that you get to keep taking advantage of having your monies compounded tax-free.

Since the 401K plan is sponsored by your employee, you don't actually own the assets in your 401K plan. The plan owns them. That's why the 401 K rollover rules don't permit you to directly rollover the the monies yourself. The only entity with the authorization to do that is the trustee who is the administrator of the plan. This accounts for the additional difficulty in accessing and rolling over monies in a 401K plan. There's another level of oversight or bureaucracy that you have to go through.

According to 401 K rollover rules, in order for you to rollover your money from a 401K account, a government defined "benefit event" has to occur. There are various benefit events, but the type usually invoked for a rollover is a change of jobs. When you quit a job or are fired, you can rollover your 401K earnings into another IRA or 401K account. If your new employer has an especially attractive 401K plan, it's probably to your benefit to rollover your monies to that plan. Of course, if you feel comfortable with it and the amount is greater than $5,000, another option is to simply leave your money in your old employer 401K plan.

To rollover your money, you have to fill out what is called a 401 k rollover form or 401K-election form. You write the amount of money that you are rolling over and specify to which 401K plan or IRA that you are rolling it over to. If you want to avoid penalties and taxation, you cannot take possession of the money. So, on the 401K-election form, be sure that you specify the "direct transfer option." If, however, you cannot avoid taking possession of the money, you have up to 60 days to deposit it in an IRA or equivalent account without incurring penalties. Government regulations can always change, however, so for the most current rules regarding lump sum transfers, talk to your accountant. Direct rollover or trustee-to-trustee transfer is always the best. That way you don't have to be concerned at all of the possible tax penalties involved.

The reason for the trustee withholding 20% of the funds before cutting you a check is for federal income taxes. Until you redeposit the money, if is effectively counted as earned income and subject to withholding tax. Therefore, if you redeposit the amount in an IRA or another 401K account, you will have to make up the 20% out of pocket to bring the amount up to its prior level. In addition, if you are under the age of 59 1/2, you will have to pay 10% premature distribution penalty. You have up to 60 days to redeposit the funds into another 401K or an IRA account. Failure to do this will result in the IRS considering the entire amount as taxable income.

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