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Mike, in responding to an earlier post, wrote:

<<I am considering rolling over my 401K from my previous employer into a self-directed IRA rather than into the 401K plan at my new employer. I want the option of individual stock investing. Are there any reasons not to go with the self-directed IRA option or pitfalls to watch out for? >>

I'm considering doing the same thing. My wife used to work for a life insurance company and is worried about the tax implications of this type of action. She thinks that we will have 20% automatically withheld by the originating company and then have to come up with that 20% to put into the new account so that we don't have a tax liability. Is this true? It seems like I remember that you can have the rollover go without having to go through our checking account, but she's pretty confident her company was a bunch of sticklers about this.

Do the discount brokerages give the right paperwork to make this a non-taxable event? I'm pretty tired of sending the IRS too much money each year.

If 401k money is sent to the participant in a check made out in that participant's name, then by law the plan must withhold 20% of the funds against possible taxation of that distribution. Thus, to complete a 100% rollover of the 401k the participant must come up with the missing 20% out of other resources, add it to the 401k check, and deposit the entire amount in an IRA within 60 days after receiving the 401k check. The 20% withholding is then returned when the account owner pays his/her taxes for that year.

To avoid that problem (i.e., giving Uncle Sammy a free loan of your money), all the 401k owner must do is arrange for a direct custodian-to-custodian transfer of the 401k money. When that's done, the participant never sees the money because it goes directly from the plan to the IRA. Additionally, no money is withheld for potential taxes. A direct transfer is easy to arrange. All the 401k owner does is tell the IRA and the plan custodians that is what he/she wants to do. Both will have forms for that person to complete, but both also know how to do this. All the 401k owner has to do is follow their instructions and there is no problem.


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