Definition and Examples of Direct Rollover
A direct rollover is the complete or partial transfer of your retirement plan funds directly from one qualified retirement plan to another. In this type of rollover, the plan administrator or financial institution handles the entire transaction, and the account holder does not actually touch the funds.
A direct rollover of retirement plan distributions is not a taxable event. This allows you to move your money without any tax penalties, and your funds continue to grow tax-deferred until you withdraw them.
How Does a Direct Rollover Work?
The IRS sets the rules regarding tax-deferred retirement plans, including which accounts are eligible for rollovers, their tax rates, and associated penalties. Most types of retirement savings vehicles are eligible for rollovers, but they are subject to different rules and restrictions.
Imagine you have a 401(k) account with $10,000, and you are about to get a new job. If you transfer the full balance of your old account directly to another plan or IRA, this means two things:
- Taxes will not be withheld from the rollover amount
- You avoid the additional 10% tax on early distributions
To start the direct rollover process, simply ask your financial institution to transfer the amount to the new plan or IRA, and follow their instructions.
Alternatives to Direct Rollover
As mentioned, you have options when it comes to what happens to old retirement accounts. Let’s say you have an employer-sponsored retirement account worth $10,000.
- Indirect Rollover: If you make an indirect rollover or 60-day rollover, the plan administrator withholds 20% as required for taxes and sends you a check for $8,000. You can still rollover the entire amount within 60 days without taxes, but you will need to make up the $2,000 from another source.
- Roth Conversion: If your money is in a Traditional IRA, you can transfer it to a Roth IRA, also known as a Roth conversion. The conversion to Roth is a taxable event, meaning a withholding of 20%, or $2,000, is required on the $10,000 conversion.
- Direct Rollover: If you decide to do a direct rollover from one plan to another, or transfer between the plan’s reserve funds (moving assets from one IRA directly to another), no taxes will be withheld from the rollover amount. The full $10,000 will be transferred to your new account.
Each of these options varies in its benefits, but a direct rollover can be the easiest way to avoid tax penalties and keep as much of your money as possible.
Key Takeaways
- A direct rollover is a straightforward way to move financial assets from a retirement account, such as a 401(k) or IRA, directly to another IRA or retirement plan.
- In a direct rollover, the bank or plan administrator transfers the funds directly to the new account on your behalf.
- No taxes will be withheld from a direct rollover, allowing your assets to continue growing tax-deferred until you withdraw them later.
- If you want to do an indirect rollover or Roth conversion, there may be tax implications.
Source: https://www.thebalancemoney.com/what-is-a-direct-rollover-5208628
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