Avoiding Rollover Withholding
There are specific tax strategies that can help taxpayers avoid rollover withholding when they move money from one retirement account to another. If you need help minimizing your tax liability, consult with a reputable tax professional in your area.
Using an IRA to receive a direct transfer of an eligible rollover distribution may help a taxpayer overcome these withholding rules, because IRA distributions are not subject to the 20% withholding requirement.
If a retirement plan recipient elects to have only a portion of an eligible rollover distribution paid directly to another plan, and elects to receive the remainder, the mandatory 20% withholding applies only to the portion not directly transferred. For distributions of less than $200, no withholding is required (all eligible distributions received within one tax year are aggregated to determine whether the $200 limit is reached).If the plan administrator doesn’t know at the time of the first distribution whether there will be other eligible distributions during the year that would reach the $200 floor, no tax need be withheld on the first distribution.
Example - Partial Trustee-To-Trustee Transfer - Linda, age 60, is to receive a $45,000 cash lump sum distribution. She had contributed $7,000 (post-tax) to the plan. She instructs the plan administrator to transfer $30,000 of the distribution to an IRA and the balance to her. RESULT: The $30,000 IRA deposit is a tax-free rollover. Of the remaining $15,000, $8,000 is taxable as ordinary income and $7,000 is nontaxable recovery of Linda’s post-tax contributions to the plan. Linda’s employer will withhold income tax of 20% ($1,600) of the $8,000 ordinary income amount.
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