These Tax Rules Apply to an IRA Rollover

March 16, 2025

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MARCH 15, 2025

A woman meeting with a tax professional to discuss tax rules for an IRA rollover.

Rolling over a 401(k) or other workplace retirement plan into an Individual Retirement Account (IRA) is very common when people change jobs or retire. Among other potential benefits, a rollover lets savers combine multiple accounts to keep better track of everything. But if the rollover isn’t done right, you could end up facing a big tax bill along with unwanted IRS penalties. Direct transfers between retirement account custodians offers a simple and reliable way to avoid taxes. But with indirect rollovers involving checks, savers must carefully follow timing rules and replace any withheld funds to avoid issues. Speaking with a financial advisor can help provide clarity when weighing IRA rollover decisions.

How the IRS Taxes IRA Rollovers

When you take money out of a tax-advantaged retirement savings account such as a 401(k) or IRA, you ordinarily have to pay taxes on the withdrawn funds. However, the tax code allows people to shift retirement savings between different types of tax-advantaged accounts without paying taxes through something called a rollover.

One frequently seen rollover moves money from a former employer’s 401(k) to an IRA. You might also rollover money from your ex-employers 401(k) plan to a 401(k) run by a new employer. When you retire and leave the workforce, you may rollover 401(k) money from your last job to a new or existing IRA.

Rollovers are also divided into direct and indirect varieties. Direct rollovers transfer the money straight from the old 401(k) or IRA right into the new IRA or the new employer’s retirement plan. Since the check is not sent to the saver, no tax applies. With indirect 60-day rollovers, however, the “from” retirement account issues a check to the person, sometimes with taxes automatically withheld. As long as the full amount of the withdrawal gets redeposited within 60 days, the rollover stays tax-free, but this is a strict deadline with significant consequences if you fail to meet it.

If the 60-day deadline gets missed, the IRS treats this as withdrawing the money. This triggers income taxes on the whole rollover amount. Savers under 59 1⁄2 also now owe a 10% early withdrawal penalty. And if the sending 401(k) or IRA withheld 20% upfront for taxes, as is often the case, the saver has to put that money back too. If not, taxes and penalties apply to the missing withheld money too.

Additional rules may also apply. For example, the IRS allows only one un-taxed indirect rollover per year. Any more, and the rollover is treated as a taxable withdrawal also subject to penalties.

How a Typical 401(k)-to-IRA Rollover Works

A senior researching the rules for a 401k-to-IRA rollover.

Consider someone 42 years old who is leaving a job with a $100,000 401(k) balance. They request an indirect rollover distribution into a traditional IRA. The workplace retirement plan follows IRS rules and withholds 20% – or $20,000 – before handing over the remaining $80,000. If the saver deposits just the $80,000 within 60 days, the IRS considers the missing $20,000 a taxable distribution from the 401(k). This saver would have to pay income taxes on the unpaid $20,000 in addition to a 10% early withdrawal penalty of $2,000.

Now the saver has 60 days to add $20,000 of their own money into the IRA account along with the $80,000 check. This puts the full $100,000 into the IRA, replacing what was initially withheld. And because they directly received a rollover check, this IRA transfer counts as their one allowable indirect IRA-to-IRA rollover for the next year.

Strategies to Minimize IRA Rollover Taxes

When possible, transferring the 401(k) or IRA money directly into the new retirement account is best. This way, there’s no check written out to the saver, so no taxes or penalties can be withheld. While IRAs limit people to one rollover per year across all accounts, direct IRA-to-IRA transfers conveniently bypass this rule.

Bottom Line

A worker near retirement considers rolling over retirement plan money into an IRA.

Rolling over workplace retirement plan money into an IRA when changing jobs or retiring often makes sense. But not correctly navigating the various IRS rules can cost you through taxes and penalties. Directly transferring assets between retirement account custodians is simplest and avoids tax and penalty. If you do an indirect transfer, you’ll need to closely observe timing requirements and replace any withheld money to avoid issues.

Tips for Retirement Planning

A financial advisor may identify opportunities to reduce associated taxes and penalties when doing an IRA rollover.
Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest.

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