If you have an old 401(k), a 401(k)-to-IRA rollover could allow you to consolidate your accounts. Before you initiate a rollover, though, consider the rules, which vary by account type (such as pre-tax or Roth) and rollover type. Here are the most important rollover rules to know, along with exemptions that may influence your strategy.
401(k)-to-IRA rollover rules
If you don’t follow these rules about 401(k)-to-IRA rollovers, you could be on the hook for taxes and penalties, which could reduce your retirement savings.
60-day rollover rule for indirect rollovers
The 60-day rollover rule applies to indirect rollovers, which occur when your assets are sent to you instead of directly transferred to your new account. You have 60 days from when you receive the distribution to deposit that money (including the taxes withheld) into an IRA. Failure to meet this deadline triggers income taxes and, if applicable, a 10% early withdrawal penalty if you’re under age 59½.
There are 2 main types of 401(k)-to-IRA rollovers:
- Direct rollovers, when your assets are transferred from your previous plan’s provider straight to an IRA.
- Indirect rollovers, when your previous plan’s provider sends you your assets, which you then need to deposit into the IRA.
Covering withheld tax on indirect rollovers
Another rule for indirect rollovers: 401(k)-to-IRA rollovers are subject to automatic 20% tax withholding on taxable amounts, including pre-tax contributions, earnings, and nonqualified Roth 401(k) withdrawals. That means upon requesting a distribution from your workplace plan, a check will be sent for 80% of any pre-tax amounts. If you’re under age 59½ and are not eligible for an exception such as the Rule of 55, in order to avoid a 10% early withdrawal penalty on the amount of your rollover withheld for taxes, you must come up with the difference using other funds and then deposit those funds into your IRA as a rollover. When it’s time to file your tax returns, you might be made whole in the form of a refund for the amount withheld, but that depends on your total tax liability.
Taxes and penalties for early withdrawal
If you opt for an indirect rollover and keep some or all of the distributed funds—instead of rolling them over into an IRA within 60 days of receipt—that money may be subject to taxes and penalties.
How much you pay depends on whether the original account was a pre-tax or Roth account:
- Pre-tax: When you withdraw money from a tax-deferred account like a pre-tax 401(k) without replacing it in 60 days, it counts as taxable income. You can also expect a 10% early withdrawal penalty if you’re younger than age 59½, unless an exception applies such as the Rule of 55.
- Roth: Roth contributions can be withdrawn without triggering taxes or penalties. Earnings, if you had growth from your investments, however, are treated differently. You can generally avoid taxes and penalties if you’re at least age 59½ and the account meets the 5-year aging rule.
With the Roth 401(k) 5-year rule for withdrawals, at least 5 years must elapse between the beginning of the tax year of your first contribution to a Roth account and the time when you withdraw earnings, and you must be age 59½ or older (or meet another qualifying condition such as disability or death). If fewer than 5 years have passed before you make a withdrawal of earnings, the withdrawal is considered a nonqualified distribution and may be subject to either taxes or penalties (or both).
Rollover rules for direct transfers
Since direct IRA rollovers move money without you as an intermediary, they’re typically not subject to many of the rules that apply to indirect rollovers. There is no:
- 60-day rollover rule
- one-rollover-per-year limit
- withheld tax you have to make up for
Still, some plans may have a provision that requires rolling over smaller 401(k) plan balances, usually between $1,000 and $7,000, to an IRA established on your behalf. Balances under $1,000 may be distributed by check. You will get 30 days’ notice, though, so you can make your own plans for your money. Be sure to check your plan rules.
If you’re rolling over a Fidelity 401(k) to a Fidelity IRA, the assets are transferred electronically straight from your 401(k) to the IRA. However, if you’re rolling over a Fidelity 401(k) to an IRA at another financial institution, Fidelity will send you a check made payable to your provider for the assets that you must then forward to your new provider.
Tax rules if you convert to a Roth IRA
If you’re transferring funds from a pre-tax retirement account to a Roth IRA, that’s known as a Roth IRA conversion, which is different from a rollover. This will require you to pay income taxes on the amount you’re rolling over because the dollars are going from a pre-tax account to a post-tax one.
Just be aware that depending on your income and the size of the rollover, converting all of your funds at once could push you into a higher tax bracket. The upside is, you get tax-free withdrawals in retirement, provided certain conditions are met.1
Exceptions to IRA rollover rules
While the rules around IRA rollovers can be strict, there are exceptions:
Waiver of 60-day rollover rule
The IRS may be willing to waive the 60-day rollover rule if you were unable to complete the rollover on time due to:
- Death
- Disability
- Serious illness
- Hospitalization
- Restrictions imposed by a foreign country
- A postal error
- Incarceration
You may also qualify for a waiver if the financial institution involved in the rollover made an error. To see a full list of reasons that may qualify you for a waiver, refer to the IRS’ full list of exceptions.
Exceptions for early withdrawal penalties
If you keep some or all of your 401(k) rollover funds, you may be able to avoid the 10% early withdrawal penalty in the event you become disabled or terminally ill or you die. The penalty might also be waived if the money is used to:
- Cover birth or adoption expenses ($5,000 limit)
- Recover from a federally declared disaster ($22,000 limit)
- Pay for an emergency personal or family expense (up to $1,000 per year)
- Cover some medical expenses
This list of exceptions is not exhaustive. Refer to the IRS’ full list of exceptions to tax on early distributions.
How to open a rollover IRA
A rollover IRA is an IRA designed for transfers from another IRA or a workplace retirement account to an IRA. Unlike rolling over to a different kind of IRA, a rollover IRA keeps workplace savings separate from other IRA assets, which could make moving those dollars to a future workplace retirement account easier if the plan allows incoming rollovers. If that sounds like the right move for your financial situation, take these steps:
- Determine whether you have a pre-tax retirement account or a Roth account: If you have a pre-tax account, decide whether you want to go with a rollover IRA or a Roth conversion. Transferring the money to a rollover IRA wouldn’t be a taxable event because your dollars would stay tax-deferred.
- Choose a provider to hold your rollover IRA: Look for firms with low or no account fees with many investment options that suit your needs. From there, you can complete an application to open an account.
- Contact your old plan’s provider and request the rollover: If both your old and new providers allow, you can ask for either a direct or indirect rollover. Then follow their process for initiating it.
- Continue investing: After the rollover is complete, there’s still work to do: Select investments to continue to help grow your money.