Money in your 401(k) retirement account grows on a tax-deferred basis. You can continue to shield your money from taxes if you roll it into another retirement plan. You have a 60-day window to complete the rollover, but the time frame only applies if you take possession of the cash. Additionally, there are some instances in which you may pay a penalty if you attempt to roll over your money.
You can roll money from a 401(k) into another employer-sponsored plan or into an Individual Retirement Account. When you close your 401(k), your employer must withhold 20 percent of the distribution amount to cover taxes, though you'll eventually get this money back when you file your taxes. In the short term, you have to replenish the rollover money with cash from elsewhere. A standard 401(k) plan is funded on a pre-tax basis. You must move that money into another pre-tax account such as a traditional IRA. If your plan contains any after-tax contributions you must roll that money into another after-tax account such as a Roth IRA.
You do not have to contend with taxes being withheld or the 60-day window if you organize a trustee-to-trustee transfer. This involves providing your 401(k) plan administrator with the account details for your new investment. You do not actually gain access to the cash, so it retains its tax deferred status throughout the transfer process. However, if you move the money into a non-retirement account, your 401(k) custodian treats it as a taxable distribution and withholds money to cover taxes.
If you fail to complete your rollover within the 60-day window, the Internal Revenue Service regards the withdrawal as a taxable event. The money you receive is taxed as ordinary income at both the state and federal level. Generally, you also pay a 10 percent tax penalty if you have yet to reach the age of 59 1/2. Some exceptions to the penalty do apply -- such as if you lose your job after reaching the age of 55. You cannot reinvest your cash in a retirement account once the 60-day window has passed.
Required Minimum Distributions
Required Minimum Distribution rules are designed to force savers to begin making taxable withdrawals from retirement accounts. With a 401(k), you must begin making withdrawals in the year you turn 70 1/2 or the year you retire, whichever is later. The size of your RMD is calculated based upon the 401(k) account's value and your life expectancy. You cannot avoid taxes by cashing in your 401(k) and moving all of the money into an IRA. If you fail to make an RMD then you must pay a penalty tax equal to 50 percent of the amount of money you should have withdrawn.
- Internal Revenue Service: 401(k) Resource Guide - Plan Sponsors - General Distribution Rules
- Internal Revenue Service: Retirement Topics - Required Minimum Distributions (RMDs)
- Internal Revenue Service: 401(k) Resource Guide - Plan Participants - 401(k) Plan Overview
- Internal Revenue Service: Retirement Plans FAQs on Designated Roth Accounts