IRS 401k & IRA Transfer Rules

Congress recognizes the importance of saving money to provide for yourself and your spouse in retirement. To that end, it has authorized a number of tax-advantaged plans to encourage workers to do so, both via an employer and on their own. Congress also recognized that employees change jobs and retire, and have made provisions in the tax code to allow workers to seamlessly transfer assets from 401k plans and other workplace plans to an individual retirement arrangement, where workers have more flexibility with their investments and fewer restrictions.

Early Withdrawals from 401k Plans

If you withdraw money from a 401k plan, you have two options: You can take the cash in a lump sum, or you can have the 401k company transfer the funds directly to your IRA custodian in a trustee-to-trustee transfer. If you take a lump sum, the plan sponsor by law must withhold 20 percent of the money to pay federal income taxes. Once you have received the remainder, you have 60 days to deposit the money in an IRA, or you will be liable for income taxes, plus a 10 percent penalty in most circumstances, for those who are under age 59 and a half. The 10 percent penalty is calculated on the full amount withdrawn, including the amount withheld by the plan sponsor. Further, you must deposit the full amount withdrawn in the IRA, including the amount withheld to pay the taxes. To get around this penalty, execute a direct trustee-to-trustee transfer, called a "rollover."

401k Plan Restrictions

Some 401k plan sponsors restrict your ability to access funds during your time of employment. Withdrawals while you are employed are called "in-service distributions."

Fund Sources for IRA Rollovers

You can move money into a traditional IRA from any of the following sources: another traditional IRA, qualified retirement plan such as a 401k, SIMPLE IRA, Simplified Employee Pension Plan, or traditional defined benefit pension plan, a Section 457 deferred compensation plan, or a 403b tax-sheltered annuity plan.

Waiting Period

In most cases, you must wait at least one year from the time you executed an IRA rollover before you can roll over those same funds again.

Prohibited Rollovers

You may not execute a rollover from the following sources: RMDs, or Required Minimum Distribution, hardship distributions, distributions made to correct overcontributions, proceeds of loans treated as distributions and taxed as income, dividends on employer stocks or bonds and life insurance.

Rolling 401ks and IRAs into Roth IRAs

As of tax year 2010, there is no upper income limit on your eligibility to roll money into a Roth. However, you must pay income taxes on any amount you choose to convert to a Roth IRA. You may wish to do so if you believe income tax brackets will be higher in the future, or you do not wish to have required minimum distributions. Rollovers executed in 2010 have up to two years to pay the income taxes due. Under current law, however, that benefit applies only to 2010 conversions.