Q. I took an indirect rollover from an IRA to roll into a 401k. Let's say for $4000. At the end of the 60 day payback period, I only had $3000 available to put into the 401k, which I did. I was $1000 short. During the 60 days though, I contributed over $1000 to the 401k. Let's say I contributed $2000 via payroll deduction. Is there any way to use $1000 of the $2000 payroll deduction to offset the $1000 shortfall on the repayment? Thanks for any help.
A. 1: With an indirect rollover you receive the money directly in the form of a check. You are then to deposit that cash distribution into a new retirement account within 60 days otherwise you will face penalties. Your employer however is required to withhold 20% of your funds as prepayment for your federal income taxes. You have full use of the funds for that 60 days but if you do not redeposit it into a new 401K acct., the entire amount will be taxed and may incur penalties. To avoid any taxes or penalties, you need to deposit the full amount, including the 20% into a new 401K account.
2: It depends as long as the over contribution of $1K fully covers all the rollover costs (Or the withholding tax rates, 20%, or 10% of prepayment penalty is higher than your marginal tax rate); for example, a 401k indirect rollover does not automatically preserve the tax benefits associated with your 401k account. Because you’re being given the distribution amount , $4K, directly instead of the transfer being handled by account trustees, the IRS places additional strictures on indirect rollover to try to ensure you re-invest your retirement savings in another qualified 401k plan.The first penalty is an automatic 20% withholding of the account balance that’s designed to pay a portion of the taxes that would be due should you elect not to re-invest the funds in a new 401k account. Although the taxes due if you decide to keep the funds would likely be more than 20%, this insures the IRS that they’ll get at least a portion of the taxes that become due on the distribution.The second penalty is a 10% early withdrawal fee. Because it can’t be guaranteed that you’ll actually execute the 401k indirect rollover, the IRS also preemptively assesses this penalty based on the assumption that you won’t.To have these withholding fees credit to your new 401k account, you must open a qualified 401k account within sixty days of receiving the distribution check and make a deposit in the amount of the entire original distribution (including the amounts that were deducted in fees and withholding). To recoup the withholding, you must then file the amounts as a credit on the distribution year’s tax return.As a quick example, let’s assume that you have $30K in a IRA account and you decide on an indirect rollover:Account value: $30K; Tax withholding: 20% of $30K or $6K; Early withdrawal fee: 10% or $30K or $3K Total distribution: $30K– $6K– $3Kor $21K. To recoup the $9K in fees and penalties, within sixty days you must deposit into a qualifying 401k account the amount of $3K,NOT $21K. You’ll eventually be credited the $9K when you file your tax return but, in the short term, you must come up with that $9K on your own.As you can see, the 401k indirect rollover isn’t the preferred method the IRS wants you to use to rollover your 401k account. It’s designed to place substantial penalties on your retirement funds to help ensure that you’ll actually follow through on rolling over the money into another qualified IRA or 401k account.
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