Rollovers and Tax Withholding

Rollovers and tax withholding

A client recently explained that his 401(k) plan sponsor made an error and withheld 20% for taxes when all he did was “rollover” the 401(k) funds to an IRA. Does the plan sponsor need to issue another check for the 20%?

No. Instead of requesting a trustee-to-trustee transfer or “direct rollover,” this client had requested a distribution of eligible funds from his qualified plan (paid directly to him). When a distribution is made, the plan sponsor is required to withhold 20% for federal income tax purposes (state withholding may also be applicable).

He can still rollover the amount he received into an IRA, but he will need to make up the difference out of pocket within 60 days of the distribution to complete a timely rollover. Another option is to treat that 20% as ordinary taxable income on his tax return. However, if he chooses the second option, he will also owe a 10% early distribution penalty on the taxable portion not rolled over to the IRA because he is under 59½ years old and no other exception applies.

What is the moral of this story? Make sure you fill out your retirement plan paperwork correctly if you want to move your retirement funds tax and penalty free. Don’t be afraid to ask your personal expert for assistance, retirement distribution planning is a FREE service and (s)he is available to help you!