A 401(k) Rollover Question

Lately, we’ve been talking about how to allocate your 401(k) assets, and you’ve taught me a thing or two. Now comes this question from a couple switching jobs:

“We plan to roll over our 401(k) to an IRA account at [a well known $18-a-trade deep discount broker named after the Roman goddess of grain from which comes the word “cereal” (and also the name of the first asteroid to be discovered), but I don’t want to name it, lest I appear to be plugging that firm, toward which I have warm feelings, but from which I wish to maintain my editorial independence — A.T.].

“We called and talked to the fund manager of our previous employer and were told that if we rolled over to an IRA account, no tax will be withheld and no penalty will be applied. Is this true? Is there any limitation such as gross income or $ amount that can be rolled over in one year? Is there anything that we need to watch out for?

“Our concern is that if our combined income is about 100K, can each of us roll over about 30K this year without getting any type of penalty? Please do not include my name or email address in your reply.”

The information you got is correct. The IRS places no limit on the size of a retirement account that can be rolled over from a company plan, once you leave your employer, to your own personal IRA rollover account. (Your other good option would be to roll the money over to your new employer’s plan, if you have a new employer, and if its plan accepts rollovers.)

Incidentally, you are wise to be rolling this money straight from your retirement fund to the IRA, rather than having it paid to you first and then passing it on. If you did that, 20% would be withheld for taxes (which you would not recoup until tax-refund time) and you would also run the risk of somehow missing the 60-day deadline to complete the rollover. Then you’d have to pay taxes and (if under 59-1/2) a 10% nondeductible penalty.

There are just a few arcane exceptions to what you can rollover, but these don’t apply to you, as best I can tell. The only one remotely worth mentioning is that voluntary after-tax contributions you may have made to your 401(k) cannot be rolled over. Very few people make these extra contributions, but many retirement plans do allow them. For anyone who did make these extra contributions, that money comes back to you free of tax (because you already paid tax on it). But the money those after-tax contributions earned remains happily under the shelter of the IRA rollover.

Tomorrow: The Last Word (for Now) on 401(k) Strategies