Dyer 401k Rollover: What You Need to Know About Mistakes and Taxes

Moving your 401(k) to a new account can be a smart financial move, but mistakes in the process can lead to unexpected taxes and penalties. Whether you’re changing jobs or looking for better investment options, understanding how rollovers work is essential to avoid costly errors.

Even small missteps—such as missing deadlines or choosing the wrong type of rollover—can result in unnecessary tax bills. Being aware of potential pitfalls will help you make informed decisions and keep more of your retirement savings intact.

Rollover Eligibility

Not all 401(k) accounts can be moved freely, and employer-sponsored plans often have rules that determine when and how assets can be rolled over. If you’re still employed, your plan may restrict rollovers unless you meet specific criteria, such as reaching age 59½ or experiencing a qualifying event like disability or financial hardship. Some plans allow in-service rollovers, but these are not universally available and depend on the plan’s terms.

Leaving a job is the most common reason for initiating a rollover, but restrictions may still apply. Employers sometimes impose waiting periods before allowing distributions, or they may require a lump-sum payout if your balance falls below a certain threshold—typically $5,000. If your balance is under $1,000, the plan may automatically cash it out, which could trigger taxes if not reinvested properly.

The type of account also affects eligibility. Traditional 401(k) funds can generally be rolled into another traditional retirement account without tax consequences, but moving them into a Roth IRA requires paying income tax on the converted amount. Employer contributions, vesting schedules, and outstanding plan loans can further complicate the process. Unvested employer contributions may be forfeited upon departure, and any unpaid loan balances not repaid within the grace period are treated as taxable distributions.

Direct and Indirect Arrangements

The method used to transfer funds determines tax treatment and potential penalties. A direct rollover moves retirement savings from one account to another without the account holder taking possession of the funds. This is the preferred option because it avoids mandatory withholding and eliminates the risk of missing deadlines that could result in taxes and penalties. The financial institution handling the rollover typically issues a check payable to the receiving plan or IRA, ensuring compliance with IRS regulations.

An indirect rollover requires the account holder to receive the funds before depositing them into a new retirement account. While this option provides temporary access to the money, it comes with strict rules. The IRS mandates that 20% of the distribution be withheld for federal taxes, even if the full amount is later deposited into a new account. To complete the rollover without incurring taxes or penalties, the entire distribution—including the withheld amount—must be redeposited within 60 days. If the full amount isn’t replaced, the shortfall is treated as a taxable distribution, potentially subject to a 10% early withdrawal penalty if the account holder is under 59½.

Timing is a common issue with indirect rollovers. The 60-day deadline is strictly enforced, and missing it results in the entire distribution being treated as ordinary income. The IRS may grant a waiver for extenuating circumstances, such as financial institution errors or serious illness, but these exceptions require formal requests and supporting documentation. Additionally, only one indirect rollover is allowed per 12-month period per taxpayer, regardless of how many retirement accounts they own. Violating this rule can lead to unintended tax liabilities and penalties.

Plan Requirements

Employer-sponsored retirement plans have specific rules that dictate how and when funds can be transferred. These guidelines are outlined in the plan’s governing documents, which detail eligibility, distribution options, and administrative procedures. Some plans impose waiting periods before allowing rollovers, while others require participants to complete paperwork such as distribution forms or obtain spousal consent if married.

Plan administrators play a role in facilitating rollovers, as they must verify account details and approve the transfer. If the plan includes employer stock, special tax considerations may apply under Net Unrealized Appreciation (NUA) rules, which can impact whether rolling over shares or taking a lump-sum distribution is more beneficial. Reviewing plan documents and consulting with the administrator before initiating a transfer can prevent delays and unexpected tax consequences.

Certain retirement plans also limit the types of accounts that can accept rollovers. While traditional 401(k) balances can generally be moved into another qualified plan or an IRA, some plans restrict rollovers into Roth accounts unless specific conditions are met. Additionally, administrative fees may apply, reducing the total amount transferred. These costs vary by provider, and failing to account for them can result in an unexpected reduction in retirement savings.

Possible Tax Liabilities

Rolling over a 401(k) incorrectly can create unexpected tax burdens, particularly when dealing with pre-tax and after-tax contributions. If a rollover includes both types of funds, they must be properly allocated to avoid triggering unnecessary taxable events. Pre-tax funds should be directed into a traditional retirement vehicle to maintain tax-deferred status, while after-tax contributions can be transferred to a Roth IRA without immediate tax consequences. Failing to separate these amounts correctly may result in a portion of the rollover becoming immediately taxable, increasing the risk of an IRS audit if misreported.

Errors in handling Required Minimum Distributions (RMDs) can also lead to tax liabilities. Once an account holder reaches age 73 (as updated by the SECURE 2.0 Act), RMDs must be withdrawn annually, and these distributions cannot be rolled over. Attempting to transfer an RMD into another retirement account can result in double taxation—once when the funds are distributed and again if the IRS disallows the rollover. Miscalculating the RMD amount or failing to withdraw it entirely results in a 25% excise tax on the shortfall, though this penalty can be reduced to 10% if corrected within two years.

Excess Contributions and Penalties

Exceeding contribution limits or mishandling rollovers can result in financial penalties that reduce retirement savings. The IRS imposes strict annual contribution caps, and rolling over funds incorrectly can inadvertently push an individual over these limits. If excess contributions occur, they must be corrected promptly to avoid additional tax liabilities.

When a rollover results in an overfunded IRA or 401(k), the excess amount must be withdrawn before the tax filing deadline, including any earnings generated by the excess funds. Failure to do so results in a 6% excise tax for each year the excess remains in the account. This penalty continues accumulating until the mistake is corrected. If the excess stems from an employer plan, the plan administrator may allow a recharacterization or return of funds, but this depends on plan policies. Additionally, improper rollovers into a Roth account can create tax complications, as the IRS treats excess Roth contributions differently than traditional retirement accounts.

Notification and Reporting Obligations

Proper documentation and timely reporting are necessary to ensure compliance with IRS regulations. Rollovers must be reported on tax returns, and failure to do so can trigger audits or penalties. The IRS requires taxpayers to use Form 1099-R for distributions and Form 5498 for rollovers into an IRA. These forms help verify that funds were transferred correctly and that no taxable events occurred.

Employers and financial institutions also have reporting responsibilities. Plan administrators must issue a 1099-R when funds leave a 401(k), even if the rollover is tax-free. If the distribution is indirect, the withheld amount must be reported as federal income tax paid. Taxpayers should review these documents carefully to ensure accuracy, as errors can lead to misreported income and potential tax assessments. Keeping detailed records of rollover transactions, including confirmation statements and correspondence with financial institutions, can help resolve discrepancies if the IRS questions the transfer.