Table of Contents
What is a partial rollover?
Why would someone consider doing a partial rollover?
What to know about 401(k) rollovers
How to do a partial rollover between a 401(k) and an IRA
The bottom line
What a Partial Rollover Is & How to Do One
Oct 17, 2022
7 min read
Partial 401(k) rollovers can be an option for those who aren’t content with their 401(k) investment options or who need to bridge the retirement gap between ages 55 and 59.
Individuals with investments in an employer sponsored retirement plan can sometimes roll over part of their 401(k) funds to another employer’s retirement plan or individual retirement account (IRA). In some situations, partial rollovers can be a sensible move. To determine if it is, you’ll need to compare types of partial rollovers, IRA rollover rules, and relevant tax and withholding rules.
A partial rollover is the transfer of a portion of funds from one retirement plan or account to another retirement account. It could be an IRA rollover to another IRA, or a 401(k) rollover to another 401(k) or an IRA.
Although the Internal Revenue Service permits partial rollovers, not all employer-sponsored plans allow partial rollovers.
A partial rollover can be performed as a direct transfer between financial institutions, or it can be paid out to the investor by check for them to deposit the funds to the other retirement plan/account within a 60-day window. Partial rollovers can be tax free, so long as the money is transferred between similarly tax-deferred accounts.
Partial rollovers may be desirable when an employee terminates employment and wonders what to do with their 401(k) money. The path of least resistance would be to leave all the money where it is, in the retirement plan tied to the old employer. Others might do a full rollover into the new employer-sponsored retirement plan.
But there are times when it makes sense to do a partial rollover.
One common scenario for a partial rollover entails transferring a portion of 401(k) funds to an IRA at another financial institution, or to multiple IRAs with different investment strategies. IRAs generally have a larger palette of investment options and in some instances lower investment and service fees than 401(k)s.
An employee who separates from their employer might want to roll over some of their retirement funds into an IRA but keep some of it in their 401(k) tied to the old employer. One reason is if the 401(k) plan has a unique investment option that the saver wants to maintain as part of the portfolio mix; that piece could remain in the 401(k).
The IRS’s Rule of 55 permits those who have separated from employment after turning age 55 to take early withdrawals from their current 401(k) plan without paying the 10% early withdrawal penalty. This is one reason someone would keep at least some money in their 401(k). Once they hit age 59 ½, their IRA distributions can be taken free of the early withdrawal penalty for IRAs.
If the employee’s 401(k) retirement savings includes company stock, a full rollover to an IRA would mean they owe income tax on future withdrawals. Instead, just the stock portion of the 401(k) could be rolled over to a brokerage account. When the stocks held for at least one year are sold, the investor would owe capital gains tax, which is a lower rate than ordinary income tax.
If 401(k) partial rollovers are not done right, they can trigger extra taxes. Remember that not all employers permit partial 401(k) rollovers. Check with your plan administrator to find out if it’s possible. Here are some types of 401(k) rollovers.
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The IRS won’t tax a partial rollover as long as the money moves between accounts with the same kind of tax treatment—pretax accounts go to pretax accounts (so, for example, a 401(k) to a traditional IRA), or post-tax to post-tax (Roth IRA to Roth IRA). Mixing types may trigger taxes.
Can you rollover partial 401(k) funds to Roth IRA? Yes, but depending on the type of 401(k), taxes may be owed. If the 401(k) is a Roth 401(k), no tax would be owed because the source account and destination account are both post-tax. But if you roll over from a regular 401(k) to a Roth IRA, you would pay income tax on the distribution.
A rollover between a 401(k) retirement plan and IRA account at the same financial institution is known as a trustee transfer. A trustee-to-trustee transfer is a direct rollover between different financial institutions. Trustee transfers are the simplest means of doing a partial rollover.
A direct rollover can be done automatically from a 401(k) to another retirement plan. The plan trustee would transfer payment to the new retirement plan. There will be no need for tax withholding for a trustee transfer or trustee to trustee transfer. However, be aware that it could take some time for the original 401(k) plan trustee to process the rollover request.
A manual withdrawal from the 401(k) followed by the manual redepositing of the money to an IRA is known as an indirect rollover, or a 60 day rollover. Note that 100% of the funds withdrawn must be deposited in the IRA within 60 days. Otherwise, you would owe a 10% early-distribution penalty.
For indirect partial rollovers, the financial institution distributing the money must withhold 20% of the rollover amount for tax purposes. But you still must redeposit 100% of the money withdrawn for the rollover within the 60 day window. Because 20% of that money is withheld, this means the individual has to make up the difference out of pocket. Trustee-to-trustee transfers and direct rollovers avoid this withholding problem.
The first step whendoing any 401(k) rollover is deciding to do a direct or indirect transfer. Then, the investor must decide what percentage of their 401(k) funds they want to roll over. After the transfer is complete, the investor must report it on their tax return.
In a direct rollover, the saver would ask the 401(k) plan trustee to execute the transfer payment to the IRA. There will be no need for tax withholding for a trustee transfer or trustee to trustee transfer. However, be aware that it could take some time for the original 401(k) plan trustee to process the rollover request.
In an indirect rollover the individual could receive the partial distribution of funds from the 401(k) via check, endorse it and hand it over to the new financial institution. Or they could deposit the distribution check in a personal checking account and write a new check to go into the IRA. This all needs to be accomplished within 60 days to prevent triggering the 10% early withdrawal penalty. Keep in mind that the original financial institution withholds 20% of the distribution, and the difference has to be made up when making the deposit to the IRA.
Rollovers are reported as distributions on IRS Form 1099-R. Direct rollovers will be indicated in Box 1, and the taxpayer reports gross distribution on line 15a of IRS Form 1040.
For 401(k) partial indirect rollovers, in addition to the distribution amount in Box 1 on the 1099-R, the 20% withholding amount gets reported in Box 4 on the 1099-R. The payment date is found in Box 13. This is the date the 60-day clock started ticking. The payment amount plus the 20% must have been transferred to the IRA within 60 days to avoid a tax penalty.
A partial 401(k) rollover to a Roth IRA can avoid taxation so long as the 401(k) is also a post-tax Roth type. Otherwise, the distribution will be taxed as income.
Partial 401(k) rollovers can be useful for those who leave a job with an employer-sponsored 401(k). It can be an option for those who aren’t content with their 401(k) investment options and fees, or who need to bridge the retirement gap between ages 55 and 59 ½. Partial rollovers can be executed as direct transfers between trustees or indirect transfers that require tax withholding and must be completed within 60 days to avoid tax penalties. Rollovers between pretax plans and pretax IRAs are not subject to income taxes.
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