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How to Rollover a 401(k) into an IRA

Roth IRA or Traditional IRA

The IRS limits your IRA rollover options to a Roth or traditional IRA. Contributing the funds to either type of account allows you to avoid paying income tax on the 401(k) rollover, provided you adhere to the other conversion requirements. The main difference between the IRAs is that the Roth IRA allows you to make after-tax contributions and receive the income during retirement tax-free, whereas a traditional IRA allows you to make pre-tax contributions and pay the income tax during retirement when you begin making withdrawals.
Direct Rollover or Liquidation of 401(k) Funds

Decide between a direct rollover and receiving direct payment of 401(k) funds. If you elect to have the financial institution that manages your 401(k) liquidate the account’s assets and make a direct payment to you, you can still rollover the funds into an IRA account. However, the IRS will require the financial institution to withhold 20 percent of the payment for income taxes. You can easily avoid this by choosing a direct rollover. With a direct rollover, you provide instructions to the institution managing your 401(k) to transfer the funds directly to the institution managing the new IRA.

Make Rollover Contribution to IRA Within 60 Days

If you fail to complete the rollover within 60 days, the IRS will treat the liquidation as an early distribution. When you take an early distribution, you must report the payment as gross income on your tax return and pay a 10-percent tax penalty in addition to the income tax. The IRS provides a number of exceptions to the 60-day rollover requirement. The 60-day requirement is waived if the reason for the delay is that a financial institution fails to follow your rollover instructions, you provide the instructions within 60 days of the liquidation, the funds ultimately reach your IRA account no later than one year from the start of the 60-day period and your rollover would qualify for tax-free treatment had the financial institution followed your instructions correctly.

IRS Reference:

Tax Topic 413 – Rollovers from Retirement Plans