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May 19, 2013


expat 401 (k) Rollover Mistakes BY ROBERT L. WOLFF


olling over your 401(k) into another plan or an IRA should be an easy task, but it isn’t. There are many pit falls for the unwary. Falling into one of these pitfalls, can often result in a big tax bill. Therefore, before taking your 401(k) money and heading out for the Philippines, it pays to take the time to understand the tax aspects of your 401(k). Let’s say you have been laid off after thirty years of working for your employer and have accumulated $500,000 in your 401(k). Upon termination, you receive paperwork to be completed from your former employer to move your assets out of the 401(k) plan as quickly as possible. (The employer should not be faulted for its haste; it costs money to maintain your plan.) If your intention is to roll over your 401(k) to an IRA and you request that a check be made payable to yourself (an indirect rollover), this will be reported as a taxable event (even if you intend to roll it over within the sixty-day time limit to avoid tax and penalty). You will receive a check for $400,000 ($500,000 less the 20% mandatory federal withholding tax of $100,000). When it’s time to complete the rollover, you will need $500,000 for a total rollover. If you have a check for only $400,000, you are $100,000 short! Therefore, you need to come up with the $100,000 within the sixty-day time period that began running when you received the check from the company plan. If you can’t, you will owe federal and (if applicable) state income tax on $100,000, which in most cases will exceed $25,000. Plus a possible $10,000 early

NC May 19 issue.pmd

distribution penalty, if you have not attained the age of 55 for most retirement plans, or 59½ for plans not subject to the age 55 rule. The best way to take a distribution from a 401(k) plan (when you intend to roll it over to an IRA) is by a direct trustee-to-trustee transfer, which is sometimes referred to as a direct rollover. This is when the employer (the 401(k) plan administrator) makes the distribution check payable to the new IRA custodian for your IRA account; for example, payable as ABC Mutual Fund F/B/O John J. Smith IRA and mails it directly to the receiving custodian. When a trusteeto-trustee transfer takes place, there is no mandatory 20% federal withholding tax, because you never get possession of the money. However, if your former employer insists on mailing a check to you, a littleknown IRS rule (Regulation 1.401(a)(31)-1) also allows you to take physical possession of the check without the 20% withholding tax provided it is made payable to the IRA custodian (i.e., ABC Mutual Fund). Another potential for disaster occurs when an individual is laid off with an outstanding balance on a loan taken from their 401(k)


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plan. If you separate from service (retire, quit, or experience a layoff) and have an outstanding 401(k) loan balance, the loan payments must be continued or the plan may require that it be paid back. If the plan loan goes into default status, the entire unpaid loan balance will be reclassified as a taxable distribution, reported on IRS Form 1099-R subject to federal and (if applicable) state taxes and a 10% penalty To page 18

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5/20/2013, 5:34 PM

NC May 19, 2013 issue  

NC May 19, 2013 issue

NC May 19, 2013 issue  

NC May 19, 2013 issue