How to Roll Over a 401(k) Without Tax Surprises

A 401(k) rollover is not taxed if the money goes straight to an IRA or a new employer plan. If a check is made out to you instead, the plan must withhold 20%, and anything not redeposited within 60 days becomes a taxable distribution. The difference comes down to how the money moves.

1. Three ways money can move

The IRS describes three paths:

• Direct rollover. You ask your plan administrator to pay the distribution directly to another retirement plan or an IRA. The administrator may issue a check made payable to the new account. The IRS says no taxes are withheld from the transfer amount.
• Trustee-to-trustee transfer. For money already in an IRA, you ask the financial institution to send it directly to another IRA or a retirement plan. Again, no taxes are withheld.
• 60-day rollover. The distribution is paid to you, and you deposit all or part of it into an IRA or plan within 60 days.

The first two are generally the simpler choices because the money never passes through your hands.

2. The withholding trap in a 60-day rollover

The IRS explains that a retirement plan distribution paid to you is subject to mandatory withholding of 20%, even if you intend to roll it over. To roll over the full amount, you must make up the withheld portion with other funds.

Here is how that plays out with a $50,000 401(k) balance paid to you:

If you deposit only the $40,000 you received, the $10,000 that was withheld and not replaced is treated as a distribution. It is generally taxable, and if you are under 59 and a half with no exception, the IRS's 10% additional tax on early distributions can apply to it, which would be $1,000 on $10,000.

A direct rollover avoids all of this. The full $50,000 moves, nothing is withheld, and nothing needs to be made up.

3. The 60-day deadline

You have 60 days from the date you receive a distribution to roll it over. The IRS may waive the deadline in certain situations if you missed it because of circumstances beyond your control, but you should not plan on a waiver.

4. The one-rollover-per-year rule for IRAs

IRA-to-IRA rollovers have an extra limit. Since 2015, the IRS says you can make only one rollover from an IRA to another (or the same) IRA in any 12-month period, regardless of how many IRAs you own. The limit aggregates all of your IRAs, including SEP and SIMPLE IRAs as well as traditional and Roth IRAs, treating them as one.

Trustee-to-trustee transfers between IRAs are not 60-day rollovers, which is one more reason to move IRA money directly. The IRS also notes that an IRA distribution paid to you is subject to 10% withholding unless you elect out, which a direct transfer avoids.

5. A note on the age 55 exception

If you leave your job during or after the year you turn 55, distributions taken directly from that employer's plan are exempt from the 10% additional tax, according to the IRS's exceptions table. That exception does not apply to IRAs. If you may need to draw on the money between 55 and 59 and a half, consider this before moving everything into an IRA.

6. A short checklist

1. Ask the old plan for a direct rollover to the new plan or IRA.
2. Open the receiving IRA or confirm the new plan accepts rollovers before requesting the distribution.
3. If a check is issued, make sure it is payable to the new account, not to you.
4. Keep the paperwork: the distribution statement and the receiving account's deposit confirmation.

7. Key takeaways

• Direct rollovers and trustee-to-trustee transfers move money with no tax withheld.
• A 401(k) distribution paid to you has 20% withheld; on $50,000, you receive $40,000 and must add $10,000 to roll over the full amount.
• Any amount not rolled over within 60 days is generally taxable and may face the 10% additional tax if you are under 59 and a half.
• Only one IRA-to-IRA 60-day rollover is allowed in any 12-month period across all your IRAs.
• The age 55 separation exception applies to the employer plan, not to an IRA.