401K Rollovers Can Cost You Thousands If You Don't Do It Right

Understanding the 401k rollover rules is crucial if you don't want to end up inadvertently paying thousands of dollars in extra taxes. Although 401K plans and IRA plans are both retirement plans they are very different. If you have an IRA plan, you both control and own it. In a 401K plan, however, you do not control it. The money is held in a trust (i.e., a defined contribution plan). And you, as the employee or beneficiary, have an account in the trust. Your employer, as the trustee, manages the trust on your behalf.

Putting a 401k rollover in practice is easy. You begin by filling out a 401k rollover transfer form. Once you've completed it, you present it to your employer. Your employer will then forward it to the plan trustee who will begin the process of executing the rollover. Since most companies have a firm that administers the plan, the trustee will forward the 401K-election form to them.

If everything is in order, the firm will release the monies to the new plan. If you rollover to a 401K plan at your new company, you'll also have to complete an election form there to accept your rollover. The time involved from when you fill out the form to when the transfer is complete can take anywhere from a few weeks to a couple of months, dependent on problems cropping up. In fact, one of the most common problems delaying the rollover transaction is making mistakes in filling out the paperwork or not filling it out completely.

Another problem you might run into when attempting to roll over to another 401K plan, although not often, is that some 401K plans don't accept rollovers. If you do make mistakes in the filling our of the forms, the account trustee may send you a lump sum instead of transferring the amount to your new account. In this case, you have to act quick in getting it to a new account to avoid penalties.

You might choose not to rollover, but instead choose to leave your monies invested with your old employer. One reason for doing this is if the plan has been very successful in beating the investment earnings of other plans. Another reason would be in an instance where you either don't have another job right away, or your new employer requires that you work at the company a certain amount of time before you can enroll in the new plan. Another reason would be if the new plan does not accept rollover monies.

Before you rollover your 401K, check the rules of your IRA account to ensure that you won't be violating the IRA contribution amount ceiling. If you exceed your IRA's annual ceiling contribution amount, you may be subject to penalties. If the sum you want to transfer exceeds your IRA limit, you can either transfer it in multiple packets over a number of periods or to another account.

If the amount of money in your 401K plan is less than $5,000, the amount will normally be distributed directly to you, minus a 20% withholding tax mandated by the government.