When you leave your employer, you can receive a distribution from your retirement plan. Then you have 60 days to roll the funds into an IRA. However, your employer will be required to withhold 20 percent of the amount in your account.
Say you leave a job where you have $300,000 in a retirement plan. When you request a distribution, your employer will pay you only $240,000 and withhold $60,000 (20 percent of $300,000) for federal income tax.
If you don’t deposit the difference–$60,000 in this example–into an IRA within 60 days, the $60,000 will be taxable income to you. You’ll owe income tax and there will be less money in your IRA for future growth. In addition, if this happens before age 55, you’ll also owe a 10 percent penalty.
Fortunately, this tax trap can be avoided with a trustee-to-trustee transfer. You should create an IRA and have your employer transfer your retirement plan balance into that account. No withholding will be required.
Moreover, if you need to tap your retirement plan, you should try to avoid a rollover between ages 55 and 59 1/2. IRA withdrawals before age 59 1/2 are subject to a 10 percent penalty, in most cases.
On the other hand, you can take money from an employer-sponsored plan, penalty-free, if you were at least 55 years old in the year you left your job. In between those ages, you’re better off taking withdrawals from an employer plan rather than from an IRA, if your employer will keep holding the money for you.
