A direct rollover is straightforward, and doesn’t require much beyond signing one or two simple forms authorizing the transfer. Funds move directly from one retirement plan to another. This type of rollover doesn’t have any taxable consequences to you because you never handle the funds personally.
Whenever possible, direct rollovers are preferred. That’s because direct rollovers practically eliminate the chances of the IRS Interpreting the transfer as a distribution. If the IRS thinks your transfer was a distribution, it can lead to penalties and taxes. A direct transfer avoids the possibility of this happening. But done correctly, an indirect transfer is worth considering in specific situations.
Indirect Rollover to a Solo 401k Basics
An indirect transfer is a completely valid method to transfer retirement funds into a self directed Solo 401k. Some investors choose to do an indirect rollover instead of a direct rollover. That’s because they often want access to the money for a limited amount of time (tax and penalty free).
With an indirect rollover, the releasing custodian sometimes withholds 20% of the transfer amount. This amount is withheld to pay the taxes due on the distribution (taking money out of your retirement account). When you complete the rollover, your money is returned as a tax credit. To obtain that tax credit, you’ll need to use other funds to make up the 20% withheld.
Put the Same Amount In That You Took Out
Let’s imagine you’re rolling over $10,000 from a previous employer 401k plan. With an indirect rollover, you will receive a check from the original account for $8,000. The other $2,000 is sent to the IRS as the withheld amount. To avoid taxes you will need to make up that $2,000 so that the full $10,000 is rolled into the receiving retirement account. You receive a tax credit for that $2,000 in the year the rollover takes place. If you only deposit $8,000, you will owe taxes and penalties on the $2,000 as distributed income. That’s because that $2,000 never made it into a retirement plan.
You can rollover almost any other type of retirement account into a Solo 401k via an indirect rollover (there are exceptions for Roth accounts). The releasing custodian writes the check from the old retirement account directly to you. You can use the money however you want but there is a very strict 60-day deadline before the money must be deposited into an approved retirement account (Solo 401k). Otherwise, you will most likely owe taxes on the full early distribution amount plus penalties if you have not reached age 59 1/2.
Understand the 60-Day Rule
Sometimes an indirect rollover is called a 60-day rollover. That’s because you have 60-days to deposit funds into an approved retirement plan. You must strictly adhere to the 60-day rule to complete the indirect rollover. It’s during these 60 days (think 59 days or less) that you have access to the funds tax and penalty free. If you fail to adhere to the 60-day rule (or don’t qualify for the exception waivers), the IRS will declare the entire amount as distributed income for the year. Using the example above, taxes and penalties will be owed on the full $10,000.
Be sure to get that money in the new account on day 59. These are calendar days, not business days. The 60 days includes weekends and holidays. If the 60th day falls on a Sunday or holiday, you’ll need to make the deposit a few days early. You don’t want to mail a check to your new Solo 401k on day 59. It’s not the post date that counts. The only day that counts is the day your money is deposited into your new Solo 401k account. Even an electronic transfer can take a day or more.
Limitations on Indirect Rollovers
There is also a limit to the number of indirect rollovers you are allowed to make each year for an IRA. This is a rolling year – not a calendar or tax year. It is not December 31 of one year to January 1 a year later. It could be September 10 of one year to September 11 of the next year or any other day of the year. This rule has a limited application. The one year rule does NOT apply to transfers from an IRA to a 401k. It also does not apply to direct rollovers.
Benefitting From Your Retirement Money for 60 Days
The main reason investors consider an indirect rollover is to have access to the money for 60 days or less. Your rollover from one retirement account or to another must consist of the same property. This means that you cannot take cash distributions from one account, purchase assets with that cash, and then roll those assets over into your new 401k. If you received indirect rollover funds as a check, deposit a check into your Solo 401k.
Nabers Group understands that you want full control of your retirement funds. Although a direct rollover is the safest way to open your Solo 401k, we will work with you if an indirect rollover better fits with you financial strategy and needs.