Direct Transfer

What Is a Direct Transfer?

A direct transfer is typically a transfer of assets from one type of retirement plan or account to another, which is facilitated by the two financial institutions involved in the transfer. A direct transfer is usually done when an employee has left their job and transfers the money within their 401(k) retirement plan into an individual retirement account (IRA) or another retirement plan.

A direct transfer is also called a trustee-to-trustee transfer since the individual does not receive the money, but instead, the two financial institutions facilitate the transfer on behalf of the employee.

A direct transfer can also mean any electronic transfer of money from one financial account to another, such as a wire transfer. However, it usually refers to a direct transfer of IRA funds between retirement accounts. As a result, a direct transfer is often called an IRA rollover, but there are some distinct differences between the two since not all rollovers are direct transfers.

Understanding Direct Transfers

Transfers of funds can be processed in a number of ways. A wire transfer, for example, is an electronic transfer of money using a network of banks or financial companies. A wire transfer is a fast and secure way to move money since the account owner doesn't need to withdraw or physically handle the money.

Account owners can also initiate a transfer directly from one of their accounts to another, such as a savings account, via a mobile banking app, which is a software application installed on the mobile device.

When transferring money between retirement accounts, account holders need to pay particular attention to the type of transfer method they choose — a direct transfer is one of those choices. Sometimes an account holder might want to transfer the money within an IRA savings account into another IRA savings account at another bank. Other times, an employee might leave their job and want to transfer their 401(k) balance into an IRA or the 401(k) at the person's new job. These transfers are often called a rollover, and the IRS has outlined a few ways in which this can be done.

Types of IRA Rollovers

Below are three methods in which to transfer IRA funds between different IRA accounts. However, there are specific guidelines and rules that need to be followed to ensure the transfer is done properly in order to avoid IRS penalties and tax implications.

Direct Rollover 

A direct rollover is when the balance within a qualified retirement plan, such as a 401(k), can be transferred directly to another retirement plan or to an IRA. In other words, you would ask the retirement plan administrator to make the payment to the new account. The 401(k) administrator might issue your distribution or withdrawal in the form of a check made payable to your new account.

In other words, the check is not made payable to the account owner, but instead, it's made payable to the new account at the financial institution that's due to receive the funds. As a result, no taxes will be withheld from the transfer amount. However, the drawback to this method is that the account owner is responsible for receiving the check and depositing it into the receiving bank.

60-Day Rollover

If a distribution from an IRA or a retirement plan is paid directly to the account owner, the funds must be deposited into an IRA or a retirement plan within 60 days. Taxes will be withheld from the distribution from a retirement plan, which is typically 20% of the distribution amount. The 20% that was withheld by the IRS would be returned to the taxpayer when they filed their taxes for that tax year. 

However, the account holder would still need to deposit 100% of the balance that was withdrawn within 60 days. In other words, the account owner would have to come up with an extra 20% to ensure that the full amount that was withdrawn was re-deposited within the 60-day limit. 

If all or a portion of the funds is not deposited within 60 days, it will count as a distribution. As a result, the account owner will need to pay income taxes on that amount. Also, if the account owner is under the age of 59½, the IRS will charge a tax penalty of 10% on any of the funds that were not re-deposited into an IRA. 

Trustee-to-Trustee Transfer

A trustee-to-trustee transfer — or a direct transfer — is when the distribution is not paid directly to the account holder, nor does the account holder receive a check made payable to the new account.

The account owner would ask the financial institution holding the existing IRA to make the transfer directly from the existing IRA or 401(k) to another IRA or retirement plan. With a trustee-to-trustee transfer, no taxes are withheld from the transfer amount. Also, the transfer does not count as a distribution, meaning that the amount is not considered taxable income.

A direct transfer between two trustees — or financial institutions — is the safest method to move IRA funds from one retirement account to another.

Types of Qualified Retirement Accounts

Direct rollovers or transfers from qualified retirement plans occur when the retirement plan administrator pays the plan’s proceeds directly to another plan or IRA. The IRS provides a guide to common qualified plan requirements.

In general, qualified retirement plans meet the requirements of Internal Revenue Code Section 401(a) and are thus eligible to receive certain tax benefits. They usually come in two forms: the defined benefit plan, such as a pension plan, and the defined contribution plan, such as a 401(k). A cash balance plan is a hybrid of these two.

Examples of qualified retirement plans include: