IRA Rollover: Overview, Types, Special Considerations

What Is an IRA Rollover?

An IRA rollover is a transfer of funds from a retirement account, such as an employer-sponsored plan, into an individual retirement account (IRA). The purpose of a rollover is to maintain the tax-deferred status of those assets.

IRA rollovers are commonly used to hold 401(k), 403(b), or profit-sharing plan assets that are transferred from a former employer’s sponsored retirement account or qualified plan. An IRA rollover can also occur as an IRA-to-IRA transfer.

Key Takeaways

  • An IRA rollover allows you to transfer funds from a retirement account into an individual retirement account (IRA), while preserving the tax-deferred status of those assets.
  • There are two main types of IRA rollovers—direct and indirect⁠—and it’s crucial to follow Internal Revenue Service (IRS) rules to avoid paying taxes and penalties.
  • A direct rollover is the safest way to move assets from one retirement account to another as the funds are transferred without you handling the funds.
  • If you choose to handle the funds yourself in an indirect rollover, they must be transferred to the new IRA within 60 days. If not, you’ll be subject to taxes and penalties.

Understanding IRA Rollovers

IRA rollovers can occur from a retirement account, such as a 401(k) into an IRA, or as an IRA-to-IRA transfer. Most rollovers take place when people change jobs and wish to move 401(k) or 403(b) assets into an IRA, but IRA rollovers also happen when retirement savers want to switch to an IRA with better benefits or investment choices.

The are different types of IRA rollovers: direct and indirect. It’s crucial to follow Internal Revenue Service (IRS) rules to avoid paying taxes and penalties.

Direct IRA Rollover

In a direct rollover, the transfer of assets from a retirement plan to an IRA is facilitated by the two financial institutions involved in the transfer. To engineer a direct rollover, you need to ask your plan administrator to send the funds directly to the IRA. In IRA-to-IRA transfers, the custodian from the old account sends the rollover amount to the custodian of the new IRA.

Indirect IRA Rollover

In an indirect rollover, the assets from your existing account or plan are liquidated and the custodian or plan sponsor mails a check made out to you or deposits the funds directly into your personal bank or brokerage account. This route leaves it up to you to redeposit the funds into the new IRA.

To be considered a tax-free rollover, the money must be deposited in the IRA within 60 days. If you miss the 60-day deadline, then the withdrawal will be considered a distribution in the eyes of the IRS, and some of it may be subject to income tax as well as an early withdrawal penalty. In general, withdrawals before age 59½ from a traditional IRA trigger a 10% penalty. If you withdraw Roth IRA earnings before age 59½, a 10% penalty usually applies. Roth contributions are not subject to the penalty. The same rules apply if you are doing an IRA-to-IRA rollover.

The IRS requires your previous employer to withhold 20% of your funds if you receive a check made out to you, which cannot be recovered until you file your annual tax return. But if the check is made out to the IRA, then you will not subject to withholding. Custodians will withhold 10% from IRA distributions that you intend to roll over unless you elect out of withholding.

Some people choose an indirect rollover if they want to take a short-term loan from their retirement account—in this case, less than 60 days.

Special Considerations

IRA Rollover Limits

The IRS limits IRA-to-IRA indirect rollovers to one every 12 months. The one-year calendar runs from when you made the distribution and applies to traditional IRA-to-traditional IRA rollovers or Roth IRA-to-Roth IRA rollovers.

The limit on IRA-to-IRA indirect rollovers does not apply to distributions from employer-sponsored retirement plans or rollovers from traditional IRAs to Roth IRAs. The latter is known as a Roth conversion. Direct IRA-to-IRA rollovers are also not subject to the one-year rule.

Tax Traps

Pay strict attention to which type of IRA or other retirement account you are transferring from—and which type you are transferring to. You can easily roll over funds from a Roth IRA or a Roth 401(k) to a new Roth IRA. The same is true if you’re rolling over monies from a traditional IRA or a standard 401(k) to a traditional IRA. Anything else has significant tax consequences that you need to work through carefully before you do the rollover. Traditional IRAs and 401(k)s contain pretax funds, while contributions to Roth IRAs and 401(k)s are made with after-tax monies.

Unlike 401(k) plans, IRAs allow you to invest in a wide array of assets such as stocks, bonds, exchange-traded funds (ETFs), and mutual funds.

What is a direct rollover?

A direct rollover is when a distribution from a retirement account is not paid directly to you. Instead, the financial institution or plan sponsor holding your existing retirement funds makes the transfer directly to your new individual retirement account (IRA). A direct transfer is the easiest way to avoid taxes and early withdrawal penalties.

What is an indirect rollover?

An indirect rollover is a transfer of money from a tax-deferred plan or account to another tax-deferred retirement account, such as an IRA, in which the funds are paid to you directly.

You must redeposit the full distribution amount into another qualified retirement account within 60 days to avoid taxes and penalties.

Can I take a loan from my IRA?

While IRAs don’t allow for loans like many 401(k) plans do, you can borrow from your IRA without taxes and penalties by applying the 60-day rollover rule. It allows you to withdraw assets from your IRA if you repay the full amount within 60 days, which essentially amounts to an interest-free, short-term loan.

Article Sources
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  1. Internal Revenue Service. “Rollovers of Retirement Plan and IRA Distributions.”

  2. Internal Revenue Service. “Topic No. 557 Additional Tax on Early Distributions from Traditional and Roth IRAs.”

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