Rollover IRA Withholding 

Will a rollover IRA distribution paid directly to a qualified retirement plan participant be subject to an IRA withholding?

Yes. If an eligible rollover IRA distribution is paid to the participant, the payer must withhold 20% of the gross Rollover IRA amount. This applies even if the participant plans to roll over the rollover IRA distribution to a traditional IRA.

Rollover IRA withholding exception

Exception for employer securities: The payer does not have to withhold from an eligible rollover IRA distribution paid to a participant if the rollover IRA distribution consists solely of employer securities, plus cash of $200 or less in lieu of fractional shares.

Note: The rollover IRA amount withheld is treated as part of the rollover IRA distribution for tax purposes. If less than the full amount of the rollover IRA distribution (not including any after tax rollover IRA contributions) is rolled over, the participant may have to include in income the amount withheld but not rolled over. However, the participant can make up the amount withheld with funds from other sources.

Example: A participant in a 401k plan requests a $100,000 distribution (not a direct rollover IRA). $80,000 will be paid to the participant and $20,000 withheld for federal taxes. If only the $80,000 is rolled over into a rollover IRA, the $20,000 withheld will be treated as a taxable rollover IRA distribution subject to income tax and a 10% early withdrawal penalty if the person is under age 59½ unless an exception applies.

Income tax and penalty can be avoided if the participant rolls $20,000 from other sources into a rollover IRA within 60 days of the rollover IRA distribution from the qualified retirement plan. The $20,000 withheld is treated as additional federal income tax withheld, reported on Form 1099-R, and is applied to the person's federal tax liability on the tax return for the year of the rollover IRA distribution.

How is an outstanding loan treated?

An outstanding loan at the time of a rollover IRA is treated as a rollover IRA distribution subject to the normal 60 day rollover rules.

In addition, the full amount of the rollover IRA distribution, including the loan is subject to 20% withholding.

Taxation on the outstanding loan can be avoided by the participant contributing funds from other sources in the amount of the loan to the rollover IRA within the 60 day rollover period.

Under certain conditions it may be possible to rollover a loan from one qualified employer plan to another. You should check with both plan administrators before requesting a distribution and direct IRA rollover.