Indirect Rollover

An indirect rollover is a method of transferring assets from a tax-deferred 401(k) plan to a traditional individual retirement account (IRA). With this method, the funds are given to the employee via check to be deposited into their own personal account. With an indirect rollover, it is up to the employee to redeposit the funds into the new IRA within the allotted 60 day period to avoid penalty.

Monies that an employee transfers via indirect rollover are subject to withholding rules, which generally cost the employee 20% of the amount that is pending transfer. However, the employee has full use of the funds for the entire 60 day period, and has the choice of whether to redeposit into the IRA or not. If the employee chooses not to redeposit, the entire amount is subject to tax.

An indirect rollover contrasts with a traditional rollover in that an indirect rollover includes a written check from the employer to the employee; however, with a traditional rollover, the retirement plan administrator may pay the plan’s proceeds directly to another plan or to an IRA. IRA rollovers can occur from a retirement account such as a 401(k) into an IRA or an IRA to IRA transfer. Most rollovers (direct or indirect) occur when people change jobs, but some occur when account holders simply want to switch to an IRA with better benefits or investment choices.

In an indirect rollover the IRS insists upon a withholding penalty. Custodians or trustees must withhold 10% on checks from IRA distributions and 20% on distributions from other retirement accounts.

Taxation and penalty can also occur in the case that an employee or individual makes withdrawals from a retirement account before the age of 59.5. For example, if an individual prematurely withdraws (i.e. does not rollover/redeposit) funds from an IRA, s/he will be liable for taxation, as well as a 10% penalty. This discourages savers from spending their retirement assets prematurely.

We’ve mentioned IRAs several times above in this post. Traditional IRAs allow individuals to direct pretax income towards investments that can grow tax-deferred. This is a direct contribution (DC) plan. Another type of DC plan is the employer-sponsored 401(k). If your employer does not help sponsor your retirement (often after a set period of vesting), you should consider the traditional or Roth IRA for your own purposes. Other types of employer-sponsored plans include the SIMPLE IRA and SEP IRA.