Advantages & Disadvantages of Direct Transfers

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People move retirement assets from one plan to another with direct transfers.
People move retirement assets from one plan to another with direct transfers. (Image: Comstock/Comstock/Getty Images)

A person who has a retirement plan with a company may decide to transfer her funds to a different plan when switching jobs. This transfer can be done through electronic means, such as a wire transfer, which is called a direct transfer or a direct rollover. The advantages outweigh the disadvantages when a person wishes to switch plans in this manner.

IRS Reporting Advantage

When a person engages in direct transfers, she does not have any tax liability. She does not need to report the transfer on her income returns to the IRS. This allows the person to do as many types of transfers she wishes since there is no limit or transfer penalty.

60 Day Rule Advantage

A person using a direct transfer avoids the federal tax withholding he would experience if engaging in an indirect transfer. When the person does an indirect transfer, the company with which he is moving the funds from has to withhold 20 percent of the amount for federal taxes. He must also roll over the remaining 80 percent of the retirement funds in 60 days or become taxed. He may have to pay the standard 10 percent early penalty for distributing the retirement funds, if under the age of 59 1/2. The person has to replace the absent 20 percent of withheld funds back into the retirement plan within the same 60 day time period.

Financial Institution Transfer Advantage

By using the direct transfer, the person does not have to touch or account for the money by writing out the check. She allows the two financial institutions or employers handle the transfer of funds between the plans. The person can call her new institution and request for the transfer. This provides the person with security that all her funds will be accounted for through the two institutions or employers, and any errors made can become easily rectified.

Ineligible Plans Disadvantage

Some plans cannot be rolled over between employers for contributions. A Roth IRA cannot receive rollover contributions from retirement plans of employers. A person would have to perform a direct transfer to a traditional IRA and then roll this over into a Roth IRA. Also, if this person uses a special outside company to perform the direct transfer instead of through the employers or institutions, the outside company may have special stipulations regarding the transfer of certain funds, such as mutual funds.

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