Generally, 401(k) Plan distributions of elective deferrals cannot be made until one of the following occurs:
- You die, become disabled, or otherwise have a severance from employment.
- The plan terminates and no successor defined contribution plan is established or maintained by the employer.
- You reach age 59½ or incur a financial hardship.
The distributions can generally be made in non-periodic, such as lump-sum distributions or periodic, such as annuity or installment payments.
In most cases, individuals looking to fund a Solo 401(k) plan will generally request a direct rollover or retirement funds from their retirement account custodian. In most cases, the rollover would be tax-free as it would be considered a direct rollover that is rolled over from the existing retirement account to the new solo 401(k) plan. However, in some cases, the 401(k) plan or pension plan administrator will treat the rollover as an indirect distribution and send the funds to the individual participant subject to a mandatory 20% withholding tax. What this means, is that the individual will be receiving retirement funds equal to 20% less then he/she should have received if no withholding applied.
Any taxable amount that is not rolled over must be included in income in the year it was received. If the distribution is paid, the individual recipient will have 60 days from the date received and roll it over. Any taxable distribution paid is subject to mandatory withholding of 20%, even if the individual intends to roll the distribution over later. If the distribution is rolled over, and you want to defer tax on the entire taxable portion, the individual will have the ability to add funds from other sources equal to the amount withheld. In essence, the individual has the option of making up the amount withheld and contributed to the new Solo 401(K) plan, thus avoiding the withholding tax.
If you would like to learn more about how to avoid the withholding tax on a 401(k) plan distribution to a Solo 401(k) plan, please contact a Solo 401(k) plan tax expert at 800-472-0646.