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A 401(k) Rollover is when a person directs the transfer of funds in a retirement account to a new plan or IRA. The IRS gives sixty days from the date an IRA or retirement plan distributes to roll it over into another plan or IRA. Individuals are allowed only one rollover per 12-month period from the same IRA. This one time allotment does not apply to plan-to-plan rollovers and certain other kinds of rollovers.
A 401(k) Rollover is technically counted as income and will show up on the income summary when the individual does their taxes. However, it is not taxable income (so long as the rollover was done to a Traditional IRA), so it would not affect your income numbers on the tax return Adjustable Gross Income (AGI) and taxable income.
The reality is that there are several reasons why an individual would either choose to or find the need to rollover their 401(k). Whenever a person changes jobs, for whatever reason that may be, there are several options available to the individual when it comes with deciding what to do with their 401(k)-plan account. Some options include cash it out, leave the money where it is, transfer the funds to a new employer plan account if it is available with the new employer, or rollover the 401(k) into an Individual Retirement Account (IRA).
To cash out a 401(k) generally is not a smart decision for most individuals, there are a number of fees and penalties associated with this choice. For most people, the best choice tends to be a rollover into an IRA, this is especially true for individuals who are not nearing retirement or at an age when they must start taking required minimum distributions from a plan. Several reasons to rollover the 401(k) into an IRA include investment choices, communication, lower fees, potential to open a Roth account, cash incentives from brokers, fewer rules and regulations, and estate planning advantages.
When completing a 401(k) Rollover into an IRA, an individual may or may not have to pay taxes on the rollover. In most cases, 401(k) Rollover tax comes into play when the pre-tax funds from the 401(k) are being rolled over into a Roth IRA instead of a Traditional IRA because a Roth IRA is funded with post-tax earnings. A 401(k) account is a pre-tax account. The employer takes funds out of your check for your 401(k) before deductions and taxes. This reduces the overall taxable income and defers taxation until you start taking withdraws from the account.
Fortunately, IRA contribution limits do not apply to rollover contributions. If there is $10,000 in your 401(k) or $100,000, you can rollover the entire amount to an IRA. When the rollover is complete, the individual is subject to annual contribution limits moving forward.
If an individual decides to take a lump sum distribution instead of implementing a rollover into an existing or new IRA, there will absolutely be income tax taken out of the lump sum before disbursement. There also may be early withdrawal penalties involved if the person is under the age of fifty-nine at the time of disbursement. Often times, individuals will choose other options available instead of taking the financial hit of paying taxes now and paying the penalties. It is important to note that if an individual does not make a decision in time and misses the sixty-day deadline, there may be a number of tax and fee implications involved. It is best to meet with us as soon as you know you will need to make a decision so that we can help in the process and get it done before the deadline.