Here’s a sample of questions my clients commonly have about retirement plan rollovers.
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ONE: If I roll it over into my current 401K, would that rollover be a tax free transaction?
ANSWER: Yes, rollovers are tax-free as long as the rollover is done properly. The best way to do a rollover is “trustee-to-trustee,” meaning you never actually possess the money. Instead, it goes directly from the old account into the new account.
TWO: If I roll it over into a 401K and later decide to draw on the account if I find I need the money, would the tax implications be the same as if I took the lump sum now?
ANSWER: Sort of. You can’t withdraw money from a 401k until you retire or you leave the company. As long as you’re working there, you can’t take the money out. There are limited exceptions for “hardship withdrawals,” but not every plan allows hardship withdrawals. Your current plan might also allow loans to be made against your account. But in general, the funds would not be available for withdrawal if rolled into the new plan.
THREE: If I choose to open a Roth IRA with the funds, would there be any tax implications?
ANSWER: The amount transferred from the 401k plan into the Roth is counted as income on your tax return in the year of the transfer. It is not subject to the early withdrawal penalty but it would count as taxable income.
The upside is Roth accounts grow tax-free, and withdrawals down the road are tax-free. The downside is, the transfer is counted as taxable income in the year of transfer. So if you’ve got $20,000 in the 401k and you transfer it to a Roth, you would have to claim $20,000 as income this year, which would obviously have an impact on your taxes this year.