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Understanding IRA Rollover Rules: A Comprehensive Guide

By Pam O’Brien · November 26, 2023 · 7 minute read

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Understanding IRA Rollover Rules: A Comprehensive Guide

If you’re leaving your job, there are numerous things you must attend to before you clock out for the last time. One task that’s extremely important is figuring out what to do with the retirement account you have set up through the company you’re leaving.

Once you separate from your employer, you will have a few options to choose from when deciding what to do with your retirement savings, including doing an IRA rollover.

Read on to learn more about IRA rollovers and the IRA rollover rules.

What is an IRA Rollover?

An IRA rollover is the movement of funds from a qualified plan, like a 401(k) or 403(b), to an IRA. This scenario could come up when changing jobs or when switching accounts for reasons such as wanting lower fees and more investment options.
There are several factors to be aware of regarding what an IRA rollover is and how it works.

People generally roll their funds over so that their retirement money doesn’t lose its tax-deferred status. But, let’s say you leave your job and want to withdraw the money from your 401(k) so you can use it to pay some bills. In this case, you’d be taxed on the money and also receive a penalty for withdrawing funds before age 59 ½.

However, if you roll your money over instead of withdrawing it, you don’t have to pay taxes or penalties for an early withdrawal. Plus, you can keep saving for retirement.

When you roll funds over to a new IRA, you should follow IRA rollover rules that can help ensure you do everything legally, don’t have to pay taxes, and don’t pay penalties for any mistakes.

💡 Quick Tip: Did you know that you must choose the investments in your IRA? Once you open a new IRA and start saving, you get to decide which mutual funds, ETFs, or other investments you want — it’s totally up to you.

The Difference Between Direct and Indirect Rollovers

You can choose between two types of rollovers and it’s important to know the differences between each.

Direct Rollovers

First, you may choose a direct rollover, which is the moving of funds directly from a qualified retirement plan to your IRA, without ever touching the money. Your original company may move these funds electronically or by sending a check to your IRA provider. With a direct rollover you don’t have to pay taxes or early distribution penalties since your funds move directly from one tax-sheltered account to another.

Indirect Rollovers

The second option is an indirect rollover. In this case, you withdraw money from your original retirement account by requesting a check made out to your name, then deposit it into your new IRA later.

Some people choose an indirect rollover because they need the money to accomplish short-term plans, or they haven’t decided what they want to do with the money upon leaving their job. Other times, it’s because they simply don’t know their options.

Differences

Many people prefer a direct rollover to an indirect rollover, because the process is simpler and more efficient. With a direct rollover, you aren’t taxed on the money. With an indirect rollover, you are taxed, and if you’re under 59 ½ years old, you have to pay a 10% withdrawal penalty, unless you follow specific IRA rollover rules. You should consult with a tax professional to understand the implications of an indirect rollover prior to making this election.

Keep in mind that a transfer is different from a rollover: A transfer is the movement of money between the same types of accounts, while a rollover is the movement of money from two different kinds of accounts, like a qualified plan into a traditional IRA.

The IRA One-Rollover-Per-Year Rule

You can only do an IRA-to-IRA rollover once every 12 months, although there are some exceptions. You’ll want to familiarize yourself with this information to follow the IRA rollover rules.

If you’re rolling funds over from an IRA, you can only complete a rollover once every 12 months. There are exceptions, such as trustee-to-trustee transfers and rollovers from a traditional IRA to a Roth IRA, which are commonly referred to as conversions.

And, most notably, the one-year rule does not apply to IRA rollovers from an employer-sponsored retirement plan like a 401(k).

The Crucial 60-Day Rollover Rule

If you choose to do an indirect IRA rollover, you have 60 days to deposit the funds into a rollover IRA account, along with the amount your employer withheld in taxes. That’s because IRS rules require you to make up the taxes that were withheld with outside funds. Otherwise, you will be taxed on the withholding as income.

If you deposit the full amount — the amount you received plus the withheld taxes — you will report a tax credit of the withheld amount. The withholding will not be returned to you, but rather settled up when you file that year’s taxes.

What You Can and Cannot Roll Over: Limitations and Eligibility

There are some rules about the types of assets you can roll over into an IRA.

Types of Distributions Eligible for Rollover

You can roll over almost any type of distribution from your IRA, with a few exceptions (see more information on that below). However, there is one key point to keep in mind.

The same-property rule says that when you withdraw assets from your retirement account, you must deposit those exact same assets into your IRA.

For example, if you take out $10,000, then $10,000 must go into your IRA, even if some of the original withdrawal was withheld for taxes. If you withdraw stocks, those same stocks must go into the new IRA, even if their value has changed.

This means that when you withdraw money, you can’t use the cash to invest, then put the money you earn from those investments into the IRA. That money would be considered regular income, so you’d be taxed on it.
If you break this rule, not only will you have to pay taxes, but you may also be required to pay a penalty.

Exemptions and Restrictions on Rollover Eligibility

You cannot roll over your annual required minimum distributions (RMDs), which you must take annually when you turn 73.

Also, you cannot roll over loans that were taken as distributions or hardship distributions from your retirement account.

IRA Rollovers and Taxes

Taxes will not be withheld if you do a direct rollover of your retirement account to an IRA or another retirement account.

However, if an IRA distribution is made to you, it’s typically subject to 20% withholding.

Compatibility Rules When Rolling Funds to an IRA

Unfortunately, you don’t always have the ability to transfer funds directly from one type of retirement account to another. You can roll over from certain types to others, but not every kind of account is compatible with every other account. For example: You can roll funds from a Roth 401(k) into a Roth IRA, but not into a traditional IRA; and you can roll funds from a traditional IRA into a SIMPLE IRA, but only after two years.

Rules Specific to 401(k), 403(b), and Other Employer-Sponsored Plans

If you have a Roth 401(k) or 403(b), you can roll the money in those accounts into a Roth IRA without paying taxes. However, if you have a traditional 401(k) or 403(b), you can still roll over the funds, but it will be considered a Roth conversion. In this case, you’ll need to pay income taxes on the money.

When in doubt, check the rules at irs.gov, and consult a tax advisor to confirm you’re making the right moves.

Your Rollover IRA: How to Optimize and Manage It

If you don’t already have an IRA provider, choose the one you want to use to open your new IRA. You can look for a provider that gives you the kind of investment options and resources you want while keeping the fees low to help you save as much as possible for retirement.

An online broker might be right for you if you plan to manage your investments yourself. Another option is a robo-advisor, which can provide help managing your money for lower fees than a human advisor would. But then again you might feel most comfortable with a person helping to manage your account. Ultimately, the choice of a provider is up to you and what’s best for your needs and situation.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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