As seen in the Marietta Daily Journal: Bil Lako, CFP®, highlights some common mistakes investors make when it comes to required minimum distributions.
Read the article below or at the Marietta Daily Journal.
One of my friends retired right before the holidays. It was a well-deserved retirement. He experienced everything you want your final month at work to be—a junior partner, who he had trained, acquired his client accounts; the firm owners paid him for all the overtime, vacation, and bonuses he earned, and his long-term clients even attended his going away party.
It really seemed he had everything tied up in a bow. That is, until right before the holiday when he called me in a panic. Somewhere there was a communication failure, and his 401(k) administrator cut him a check for his 401(k) balance rather than complete the intended trustee-to-trustee transfer to his IRA. Panic ensued as he thought he had to roll it over by year-end. Thankfully, I was able to talk him down, and reassured him that everything was going to be OK. We just had to look carefully at the circumstances.
Normally when you separate from your employer, you can roll your 401(k) balance into a Rollover IRA. The plan administrator deposits the money directly into your IRA, and then it is up to you to invest those funds according to your overarching financial plan. However, sometimes the plan administrator will send the former employee a check. Maybe you didn’t provide new account information in a timely fashion; maybe you had less than $1,000 in the plan, or maybe it was just a mistake. Either way, it happened, and they also withheld 20% for taxes, because any time you take ownership of the money, it is considered a withdrawal. All is not lost. You have 60 days to roll over the funds to your IRA. This did not have to be completed by year-end, so my friend’s panic was all for naught. However, there was some planning that needed to be done.
Most importantly, he must complete the rollover within 60 days of the date the funds are paid from the plan. This means that if he wants to roll over the entire distribution amount and avoid taxes on the distribution, he will need to come up with that extra 20% that was withheld from other funds. Even though the IRS received the “distribution,” if he doesn’t include that withheld amount in his rollover, he will be taxed on it as if it were ordinary income—and that just stings. If he were younger than 59 ½, he would also owe a 10% early distribution penalty.
Thankfully, my friend is of retirement age and his former employer paid him for overtime, bonuses, and vacation he had earned prior to retirement. He was fortunate to have cash on hand. We will make sure that his entire 401(k) balance is deposited into his IRA, and he will receive the 20% withholding back when he files his 2021 taxes. If properly completed, rollovers aren’t subject to income tax.
You can see how an indirect rollover could be costly to an investor who did not have the ability to float the 20% withholding. While a portion of the mandatory withholding would be returned when you file your tax return because you can prove you deposited the remaining funds within a 60-day window, the IRS is still going to tax you on the amount not rolled over. In certain circumstances, the IRS may waive the 60-day rollover requirement if you missed the deadline because of circumstances beyond your control.
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