Using a rollover to transfer money from one tax-advantaged retirement account to another can be tricky. One thing you must understand is the 60-day rollover rule, which requires you to deposit all your funds into a new individual retirement account (IRA), 401(k), or another qualified retirement account within 60 days.

Most folks see it as a ticking time bomb. However, if you have a need for cash and your retirement funds are your best source, the 60-day rollover rule can be used to your advantage.

Key Takeaways

  • With a direct rollover, funds are transferred straight from one retirement account to another.
  • With an indirect rollover, you take possession of funds from one retirement account and personally reinvest the money into another retirement account—or back into the same one.
  • The 60-day rollover rule says you must reinvest the money within 60 days to avoid taxes and penalties.

Rollover Review: Direct and Indirect Rollovers

Most rollovers happen without anyone actually touching the money. Say you’ve left your job and want to roll over your 401(k) account into a traditional IRA. You can have your 401(k) plan administrator directly transfer the 401(k) money to the IRA you designate. You can do the same thing with a new 401(k) plan at a new job. This sort of trustee-to-trustee transaction is called a direct rollover. You avoid both taxes and hassle with this option.

You can also receive a check made out in the name of the new 401(k) or the IRA account, which you forward to your new employer’s plan administrator or the financial institution that has custody of your IRA. For most people that option just adds a step, though it’s sometimes necessary if the old plan administrator can’t do the trustee-to-trustee thing. Still, this counts as a direct rollover: Taxes won’t be withheld because technically you never took possession of the funds—the check for them was made out to the account.

In some cases, however, you might want to take actual control of the funds, with the aim of transferring the money to a retirement account yourself. This is called an indirect rollover. You can do it with all or some of the money in your account. The plan administrator or account custodian liquidates the assets and either mails a check made out to you or deposits the funds directly into your personal bank/brokerage account.

Applying the 60-Day Rollover Rule

The 60-day rollover rule primarily comes into play with indirect rollovers, which the Internal Revenue Service (IRS) actually refers to as 60-day rollovers. You have 60 days from the date you receive an IRA or retirement plan distribution to roll it over to another plan or IRA. If you don’t, the IRS treats your withdrawal as, well, a withdrawal—and if you’re under the age of 59½, an early withdrawal at that. You get socked with income taxes on the entire amount, and if you’re under 59½ you pay a 10% penalty as well.

That’s why most financial and tax advisors recommend direct rollovers—there is less likelihood of delays and mistakes. If the money goes straight to an account or a check’s made out to the account (not you), you have deniability in saying you ever actually took a taxable distribution should the funds not be deposited promptly. Still, even with direct rollovers, you should aim to get the funds transferred within the 60 days.

One other way to get money from your IRA before age 59½ takes advantage of a little-known section of the IRS tax code known as Rule 72(t). It exempts you from the usual withdrawal penalty if you take the funds according to a specific schedule, which lasts for five years or until you reach 59½, whichever is longer.

The 60-day rollover rule essentially allows you to take a short-term loan from an IRA or a 401(k).

Using the 60-Day Rollover Rule for Loans

Why would you ever do an indirect rollover, given the ticking clock? Well, perhaps you need to detour the funds on their trip from retirement account to retirement account. The IRS rules say you have 60 days to deposit to another 401(k) or IRA—or to re-deposit it to the same account. This latter provision basically gives you the option to take a short-term loan from your account.

It's a strategy that primarily works with IRAs, as many—though not all—401(k) plans often allow you to borrow funds anyway, paying yourself back over time with interest. Either way, the 60-day rollover rule can be a convenient way to borrow money from a normally untouchable retirement account on a short-term basis, interest free.

Taking temporary control of your retirement funds is simple enough. Have the administrator or custodian cut you a check. Do with it what you will. As long as you redeposit the money within 60 days after you receive it, it will be treated just like an indirect rollover.

Avoiding Taxes with Indirect Rollovers

However, there is a tax complication. When your 401(k) plan administrator or your IRA custodian writes you a check, by law they have to automatically withhold a certain amount in taxes, usually 20% of the total. So you won’t get as much as you may have figured on. To add insult to injury, you need to make up the amount withheld—the funds you didn’t actually get—when you redeposit the money if you want to avoid paying taxes.

An example: If you take a $10,000 distribution from your IRA, your custodian will withhold taxes—say, $2,000. If you deposit an $8,000 check within 60 days back into the IRA, you’ll owe taxes on the $2,000 withheld. If you make up the $2,000 from other sources of income and redeposit the entire $10,000, you won’t owe taxes.

How to Report Indirect Rollovers

There are three tax-reporting scenarios. Continuing with the $10,000 rollover example above:

  1. If you redeposit the entire amount you took out, including making up the $2,000 in the taxes withheld, and you meet the 60-day limit, you can report the rollover as a nontaxable rollover.
  2. If you redeposit the $8,000 you took out but not the $2,000 taxes withheld, you must report the $2,000 as taxable income, the $8,000 as a nontaxable rollover, and the $2,000 as taxes paid, plus the 10% penalty.
  3. If you fail to redeposit any of the money within 60 days, you should report the entire $10,000 as taxable income and $2,000 as taxes paid. If you’re under 59½, you’ll also report and pay the additional 10% penalty, unless you qualify for an exception.

The Bottom Line

Obviously, you should only use this strategy if you’re 100% certain you’ll be able to redeposit the money within the 60-day window. Also, bear in mind that during any 12-month period, you’re allowed only one indirect IRA rollover (even if you have several IRAs). However, direct rollovers and trustee-to-trustee transfers between IRAs aren’t limited to one per year, nor are rollovers from traditional to Roth IRAs.

Advisor Insight

Rebecca Dawson
President, Dawson Capital, Los Angeles, Calif.

If you withdraw funds from a traditional IRA, you have 60 days to return the funds or you will be taxed. If you are under 59½ you will also pay a 10% penalty, unless you qualify for an early withdrawal under these scenarios:

  • After IRA owner reaches 59½ 
  • Death
  • Total and permanent disability
  • Qualified higher-education expenses
  • First time home buyers up to $10,000
  • Amount of unreimbursed medical expenses
  • Health insurance premiums paid while unemployed
  • Certain distributions to qualified military reservists called to duty
  • In-plan Roth IRA rollovers or eligible distributions contributed to another retirement plan within 60 days

There's one other option: A little known section of the IRS tax code allows substantially equal periodic payments annually before 59½. It stipulates that you take money out of your IRA for five years or until age 59½, whichever is longer.