Avoid Errors and Penalties When Rolling Over your 401k

The IRS generally allows the owners of qualified funds (i.e. 401ks and IRAs) a 60 day grace period when rolling over money from one qualified account to another. For example, if you part ways with your employer and you want to get your hands on that 401k you accumulated over the years, you can take possession of those funds and do with them as you please as long as you deposit the funds into an IRA or other qualified plan within the allotted 60 day period.

If you fail to deposit the funds into an IRA or qualified plan within the 60 day period, the entire amount of your distribution will become immediately taxable. In addition, if you are under age 59 ½ you will most likely be subject to an additional 10% penalty. Ouch!

In past years, the IRS has established a pattern of giving the investor the benefit of the doubt when they had a misunderstanding of the rule, received bad advice from an advisor, or were the victim of a banking error. The government’s take on this may be changing, however, and investors need to take note. According to Kelly Greene’s column in the Money & Investing section of the June 14, 2008, The Wall Street Journal, the IRS has gotten stingier with such waivers.

The best line of defense against not sending Uncle Sam 20%-45% or your retirement savings (depending on your tax bracket) is to not take custody of your 401k rollover. Consider having your 401k rollover dollars sent directly to the receiving account, which in a normal rollover situation will be the custodian of their IRA rollover.

If the custodian of your 401k doesn’t allow the rollover check to be sent anywhere other than the address of record, which is normally your home, you should make sure the 401k custodian issues the check payable to your IRA rollover custodian, for the benefit of your IRA. (i.e. Check payable to: Scottrade F.B.O. Randy Smith IRA Rollover) It is also a good idea to have your IRA rollover account number printed clearly on the check. Upon receipt of your 401k rollover check, you should make a copy of it for your records and immediately forward it to your IRA rollover custodian. Do not deposit the check into your checking account prior to sending the funds to your IRA.

A second line of defense is to proactively check your IRA rollover statement or the custodian’s website to ensure your rollover funds reached their destination safely. If you do not see the funds deposited in a timely manner, you should call the custodian of your former employer’s 401k plan and request that they conduct the research necessary to see if the check has cleared their bank.

The 401k rollover process should be a smooth transition from your former employer’s 401k plan into your IRA rollover. There are many advantages to taking control of your retirement dollars and rolling them into an IRA. The IRS has established rules that govern the 401k rollover process and they need to be followed closely, especially in an environment where it is getting harder to receive forgiveness.

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