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20% Withholding

Effective January 1, 1993, the process of rolling over qualified plan monies was simplified by the passage of the Unemployment Compensation Amendments of 1992 (UCA-92). The effect of the law was to (1) expand the range of distributions from qualified plans (including qualified annuities) that are eligible to be rolled over, (2) mandate direct rollover options and (3) institute a 20% withholding if certain qualified plan assets are not rolled directly into an IRA or another qualified plan.

Specifically, it requires a mandatory 20% withholding from rollovers when the participant takes receipt of the funds. In other words, 20% of the rollover will be withheld by the distributing trustee as assumed federal income tax before it is distributed to the participant. Since indirect rollovers allow participants to take possession of the distribution and actually use the money for up to 59 days, the IRS takes the position that the rollover might never take place and it wants its due up-front.
The withholding applies only to rollovers from qualified plans, not from IRAs, and only when the distribution is made to the participant. Participants may, at their discretion and out of their own pockets, make up the 20% withheld from the rollover. They can then claim and receive back the 20% on their income tax return. However, if a participant does not make up the 20%, then a distribution is deemed to have been made and will be taxed accordingly. This may include a penalty of 10% if the participant is under age 59.5.

For example, an indirect rollover of $50,000 from a profit-sharing plan would require the trust to withhold $10,000 for income taxes. The participant would receive a check for $40,000. However, unless he or she rolls over a full $50,000, a distribution equal to the amount not rolled over takes place. Therefore, if the participant in this case did not make up the $10,000 difference, and rolled over only $40,000, he or she would be considered as having taken a $10,000 distribution. Taxes would be owed on that amount as would a penalty of $1,000 if the participant were younger than 59.5. (These taxes and penalties are taken out of the amount withheld.)

Last Updated: 9/23/2012 10:05:00 PM