Here's What Happens During an Indirect 401(k) Rollover

The retirement account you start off saving in isn't necessarily the account you'll have forever. Many people switch jobs every few years, for example. And when they do, they often take their 401(k) plan balances with them and move that money into a new retirement plan. 

If you have a 401(k) through an employer you're leaving or have already left, it's generally best not to keep your money where it is. A better bet is usually to move that money into a new qualified retirement plan. That could be an IRA you open and manage yourself, or a 401(k) that a new employer is offering you.

But in some cases, you might have to play an active role in getting that money transferred over. And you'll need to be really careful to follow the rules so you don't end up getting taxed and penalized in the process.

How an indirect rollover works

With an indirect 401(k) rollover, your old 401(k) funds aren't transferred directly into a new retirement plan. Rather, you get a check for your old 401(k) balance, and it's then on you to move that money into another retirement account, whether it's a 401(k) or an IRA.

The problem with an indirect rollover is that if you don't complete it within 60 days, the money you've cashed out of your 401(k) will be treated as a withdrawal. And if you're not yet 59 1/2 years old, it will be considered not just a regular withdrawal, but an early one. 

In that case, you're usually looking at a 10% penalty on the sum in question. So if you have a $10,000 401(k) balance you don't move over to a new plan in time, you'll face a $1,000 penalty. 

Plus, unless you have your money in a Roth IRA or 401(k), your retirement plan withdrawals will be taxable. So in addition to a 10% penalty, you might also face taxes on your 401(k) balance if you don't get those funds moved over in time.

Be careful when using your 401(k) as a short-term loan

For some people needing to move over a 401(k), a direct rollover just isn't an option, so they're stuck with an indirect rollover. But you may be tempted to intentionally request an indirect rollover if you have a short-term need for money and want to borrow some temporarily from your 401(k) balance. 

This, however, is a very risky thing to do. If you don't manage to transfer over your entire balance to a new retirement plan within 60 days, any funds you don't move over will be considered a withdrawal, leaving you on the hook for taxes and possibly an early withdrawal penalty, depending on your age. 

So tempting as it may be to hit up your 401(k) during that time when you're rolling over your money, you're better off finding another way to borrow if you have that need.