What Is a Direct Rollover?

If you’re considering changing jobs or starting a business, make sure you don’t throw away any retirement funds you’ve built up. Whether you have worked at the same place for decades or are making a career change in your twenties, you can roll an old employer-sponsored 401(k) into a different retirement account tax-free with a direct rollover. Here’s how it works. A financial advisor can help you with rollovers or any other retirement planning questions.

A direct rollover is an untaxed transfer of money from one retirement account to another. The money that’s moved over is called a rollover contribution. Direct rollovers allow you to consolidate your retirement funds without incurring any penalties.

As a result, if you get a new job or retire, a direct rollover allows you to move the full value of the retirement plan provided by your employer to your own individual retirement plan (IRA) or new 401(k). With a direct rollover, the money distributed never comes into your hands; it goes from one account to the other. This way circumvents the 20% penalization from the IRS. Therefore, you can cash out your 401(k) and retain all your cash and assets for retirement.

One exception to the IRS regulations is if your account has less than $1,000. If so, your employer will most likely close the account and send you a check for the total balance. This check will have already subtracted income taxes. However, the IRS will not impose its early withdrawal penalty if you deposit the money into another qualified retirement account within 60 days. If you don’t, the government will tax the money to the fullest extent: as income and as an early withdrawal if you are younger than 59 and a half.

Direct Rollover Examples

Let’s say you change jobs and have a 401(k) from your old job with $20,000 in it. Instead of cashing out the plan and paying a $4,000 penalty, you initiate a direct rollover to your new employer-sponsored 401(k) plan. Consequently, you keep going strong with your retirement plan and can continue to pile more cash onto your original $20,000 after starting your new job.

In another scenario, you might be retiring at age 65 with $500,000 in your employer-sponsored plan. Over the last several years, you have contributed to your own IRA in addition to the 401(k) from work (an excellent retirement strategy if you can max out your 401(k) contributions).

Upon retirement, you intend to start withdrawing from your retirement plan. However, you don’t need a lump sum of $500,00 – nor do you want to pay taxes on that amount of income. You also don’t want to leave that amount of wealth in a savings account when it could yield higher returns. So, you implement a direct rollover into your IRA, giving you a better return rate and avoiding high taxation. You’ll take the monthly distribution you need while the rest of your cash remains in an IRA and continues to be invested.

How Does a Direct Rollover Work?

To conduct a direct rollover, you must communicate with your retirement plan administrator. The administrator is usually a separate company from your employer. First, you’ll provide the needed information for your new qualified retirement account. Then, the trustee from your old plan will distribute the funds in your account to your new plan administrator. If this process finishes within 60 days, your retirement funds will remain untaxed and unpenalized.

Direct Rollover: Alternative Solutions

A direct rollover is not your only option for your retirement account. You can take two other actions that will incur taxes but still allow you to move your money.

An indirect rollover within the 60-day window will cost you 20% of your account’s value in taxes. You receive the remaining 80% in a check and can deposit the original value of your retirement into another account. For example, if you conduct an indirect rollover with an old retirement account of $5,000, your employer will withhold taxes and give you a check for $4,000. If you take action within 60 days, you’re entitled to deposit up to $5,000 into another retirement account tax-free. However, making up the $1,000 lost in this scenario is up to you. You’ll have only $4,000 to contribute to your new account if you don’t have any spare cash.
A Roth conversion allows you to place money in a traditional IRA into a Roth IRA. The government taxes Roth conversions at 20%.

The Bottom Line

A direct rollover helps you take full advantage of how hard you worked for your retirement in the event of a job change or decision to leave the workforce. Abiding by the 60-day rule is essential, as you avoid taxation and financial penalties from the IRS. If you need further guidance for a direct rollover or want to create a solid retirement plan, it’s wise to consult with a financial advisor.

Tips on Retirement Accounts

What’s the right retirement plan for you? Should you roll your 401(k) into another employer’s program or an IRA? What other options might you even have? A financial advisor can provide valuable insight and guidance on this. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Part of what will help you decide what to do with 401(k) money is how far along you are in reaching your financial goal for retirement. Use this no-cost retirement calculator to get a quick estimate of how you’re doing.