How to avoid taxes when rolling over a 401k? (2024)

How to avoid taxes when rolling over a 401k?

If you roll over your funds into an IRA or a 401(k) plan sponsored by your new employer, you should do it directly from one plan to the other without ever handling the money to avoid potential taxes and fees.

Generally, there are no tax implications if you complete a direct rollover and the assets go directly from your employer-sponsored plan into a Rollover or Traditional IRA via a trustee-to-trustee transfer.

If you're moving your retirement savings funds to a new plan through a direct rollover to a traditional IRA or a different 401(k), no tax withholding is necessary since the rollover isn't taxable. If your plan is sending you the money first (an indirect rollover), there's more to the story.

Retirement plans: A retirement plan distribution paid to you is subject to mandatory withholding of 20%, even if you intend to roll it over later. Withholding does not apply if you roll over the amount directly to another retirement plan or to an IRA.

The easiest way to borrow from your 401(k) without owing any taxes is to roll over the funds into a new retirement account. You may do this when, for instance, you leave a job and are moving funds from your former employer's 401(k) plan into one sponsored by your new employer.

This is where the rule of 55 comes in. If you turn 55 (or older) during the calendar year you lose or leave your job, you can begin taking distributions from your 401(k) without paying the early withdrawal penalty.

Bottom Line. You can rollover your 401(k) account into a CD without any penalties or taxes. But you need to make sure you're rolling over into an IRA CD, specifically. And always ensure to roll over into a like-kind account, whether a traditional or Roth retirement account, or you might get hit with a surprise tax bill ...

Roll it into a new 401(k) plan

The cons: You'll need to liquidate your current 401(k) investments and reinvest them in your new 401(k) plan's investment offerings, which will take time and some research.

This rollover transaction isn't taxable, unless the rollover is to a Roth IRA or a designated Roth account from another type of plan or account, but it is reportable on your federal tax return. You must include the taxable amount of a distribution that you don't roll over in income in the year of the distribution.

If the 60-day deadline gets missed, the IRS treats this as withdrawing the money. This triggers income taxes on the whole rollover amount. Savers under 59 1⁄2 also now owe a 10% early withdrawal penalty.

What is the best tax strategy for 401k withdrawal?

Deferring Social Security payments, rolling over old 401(k)s, setting up IRAs to avoid the mandatory 20% federal income tax, and keeping your capital gains taxes low are among the best strategies for reducing taxes on your 401(k) withdrawal.

No, you aren't paying taxes twice. Tax withheld is just an estimated advance payment of your taxes. The final tax amount can only be determined when you fill out your tax return. If too much tax was withheld, you'll receive a refund; otherwise, there'll be a tax due.

Those who wish to avoid this possible cost can do a direct rollover, electing to have the money rolled over directly into the new plan or account with no check mailed to the participant. Most financial planners and retirement plan experts recommend direct rollovers rather than indirect rollovers.

If you're taking a new job, there is no tax bite when you roll over your traditional 401(k) balance to another traditional 401(k) at a new job or, alternatively, roll over a Roth balance to another Roth balance. However, rollovers are subject to the rules that govern your new company's plan.

Bond funds, money market funds, index funds, stable value funds, and target-date funds are lower-risk options for your 401(k).

Convert the account into an individual retirement account. Start cashing out via a lump-sum distribution, installment payments, or purchasing an annuity through a recommended insurer.

Any Traditional 401(k) assets that are rolled into a Roth IRA are subject to taxes at the time of conversion. You may pay annual fees or other fees for maintaining your Roth IRA at some companies, or you may face higher investing fees, pricing, and expenses than you did with your 401(k).

Can I move my 401k to a money market account?

Can You Stop Your 401(k) From Losing Money? In a down market, you could transfer all of your holdings to cash or money market funds, which are safe but provide little to no return. (They may not even keep up with inflation.) This, however, is not typically advised unless you are nearing retirement.

You're required to report the rollover by the due date, including any extensions, for the tax return in the year the distribution occurred. A delay might lead to the IRS treating the distribution as taxable income, which could increase your tax liability and introduce early withdrawal penalties.

If you seek full management of your account, rolling the money into an IRA will likely be your best option. For more hands-off investors, leaving the money in your previous plan or rolling it over into your new employer's 401(k) will allow the money to continue to grow tax-deferred while someone else manages it.

Do you lose money when you roll over a 401(k)? Generally, no. Although there could be some minimal loss if you were to roll money over and the stock market were to rise generously when the rollover was “in transit” between accounts.