How Do Direct Rollover, Indirect Rollover Differ?

By Jon L. Ten Haagen, CFP ®

asktheexpert@longislandergroup.com

 

This is a very serious issue and if you get it wrong it will cost you big time. Please pay attention because every one of us with a qualified plan with our employer will have this possible situation down the road.

If you’re eligible to receive a taxable distribution from an employer-sponsored retirement plan (like a 401k, 403b and 457), you can avoid current taxation by instructing your employer to roll the distribution directly over to another employer plan or IRA. With a direct rollover, you never actually receive the funds, meaning you do not touch the funds.

You can also avoid current taxation by actually receiving the distribution from the plan and then rolling it over to another employer plan or IRA within 60 days following the receipt. This is called a ‘60 day’ or ‘indirect’ rollover.

But if you choose to receive the funds rather than making a direct rollover, your plan is required to withhold 20 percent of the taxable portion of your distribution. You’ll get credit for the amount withheld when you file your federal tax return. This is true even if you intend to make a 60-day rollover. You can still roll over the entire amount of your distribution, but you’ll need to make up the 20 percent that was withheld using other assets.

For example, if you’re taxable distribution from the plan is $10,000 the plan will withhold $2,000. And you’ll receive a check for $8,000. You can still roll $10,000 over to an IRA or another employer plan, but you need to come up with that $2,000 from your other funds.

Similarly, if you’re eligible to receive a taxable distribution from an IRA, you can avoid current taxation by either transferring the funds directly to another IRA or to an employer plan that accepts rollovers – sometimes called a “trustee to trustee transfer” – or by taking the distribution and making a 60-day indirect rollover (20 percent withholding doesn’t apply to IRA distributions).

Under recently revised IRA rules, you can make only one tax-free, 60-day, rollover from any IRA you own (traditional or ROTH) to any other IRA you own in any 12-month period. However, this limit does not apply to direct rollovers or trustee-to-trustee transfers.

Because of the 20 percent withholding rule, the one-rollover-per-year-rule, and the possibility of missing the 60-day deadline, in almost all cases you’re better off making a direct rollover to move your retirement plan funds from one account to another.

As always we stand by to answer and questions or to clarify what we are describing in the article(s). There is no reason for you to take direct distribution. You cannot earn anything putting the money in a bank for 59 and a half days. The fastest way for you to keep your money working for you in the market is to have it moved trustee-to-trustee. Give us a call with any questions that come up. The very best of fortune to you and have a great year. Give us a call for a second opinion. It is free and you get a great cup of coffee.

Editor’s note: Jon. L. Ten Haagen, CFP ® is not a CPA or tax advisor. Please seek help from a qualified professional.


Huntington’s Jon L. Ten Haagen, CFP, runs Ten Haagen Financial Services, Inc., a full-service independent financial planning firm, and he is here to answer your questions. In this bi-monthly column, Ten Haagen will answer your financial questions and help you with his expert financial advice. Don’t be shy, our expert is here for you, so feel free to ask away! Email your questions to asktheexpert@longislandergroup.com today, and let our expert help you.

*Ten Haagen is an Investment Advisor Representative offering securities and advisory services offered through Royal Alliance Associates, Inc., member of FINRA/SIPC, and a registered investment advisor. He is also an active community member, serving on several nonprofit boards and as executive officer of the Greater Huntington Boating Council.

**BACK IN HUNTINGTON: The offices of Ten Haagen Financial Services, Inc. have moved back to 191 New York Ave., Huntington. Friends and clients are welcome to stop by, check out the new office and share a cup of coffee with the expert!