Everything You Need to Know About IRA Rollover Rules

Rolling over your old 401(k) into an IRA (Individual Retirement Account) can be a smart financial move for investors who recently left a job or are adjusting their retirement plan strategy.

Whereas a 401(k) is an employer-sponsored plan, with an IRA, you open the account on your own and gain more control over your investment strategy. Like a 401(k), a traditional IRA has tax-deferred status, making it tax-compatible with your existing pre-tax accounts and perhaps your new employer’s plan.

An IRA rollover is a smart choice for many investors, but the IRS outlines detailed regulations you must follow when completing a rollover. This article will discuss what IRA rollovers are, how indirect 401(k) rollovers and direct rollovers work, and the rules you should be aware of.

What is a Rollover IRA?

A rollover IRA is an account used to move money from a former employer-sponsored retirement plan—such as a 401(k)—into an IRA, or Individual Retirement Account. When you have a 401(k), a financial institution holds your portfolio of mutual funds (and potentially company stock). When you change jobs, it’s possible to lose track of your retirement savings.

A 401(k) and an IRA are both retirement accounts but have different rules and policies. Here are some key differences to keep in mind:

• There are many types of IRAs: Two of the most popular options are traditional IRAs and Roth IRAs. Like a pre-tax 401(k), a traditional IRA is tax-deferred. Like a Roth 401(k), with a Roth IRA, you invest your money on an after-tax basis. Then, you can withdraw money without paying income taxes in retirement (assuming you follow all account rules for qualified withdrawals).
• 401(k)s and IRAs have different contribution maximums: With a 401(k), individuals under 50 can contribute $22,500 per year, and those over 50 can contribute $30,000. With an IRA, individuals under 50 can contribute $6,500, and those over 50 can contribute $7,500. These amounts are for the 2023 tax year and are subject to change in future years.

IRA rollovers do not count toward contribution limits. An indirect rollover requires you to follow the 60-day rollover rule and the one-rollover-per-year limit, which ensures you don’t hit with taxes or penalties. We’ll explore these rules and how to follow them later in the article.

What is an Indirect Rollover?

When you want to roll over your 401(k) into an IRA, there are two ways to move the money. You can either complete an indirect rollover or a direct rollover.

With an indirect rollover, you are in charge of removing the funds from the first retirement account and moving them into the new one. In this case, you withdraw the funds from your 401(k) and re-deposit them into your new or existing IRA account or your new employer-sponsored plan if you’ve signed on with a new employer and their 401(k) plan accepts roll-ins.

There are some risks involved with completing an indirect rollover:

• Follow the 60-day rollover rule: When you withdraw funds from a retirement account, you must re-deposit them to a new tax-advantaged account within 60 days, or you could face taxes and penalties.
• You may be subject to taxes and fees: If you don’t follow the 60-day rollover rule, the funds you withdraw may be taxed as income, charged a 10% early distribution penalty, and may lose out on the tax-deferred benefits associated with your retirement funds.
• Ensure you deposit the total funds when you reinvest: When you withdraw the funds from your 401(k), your plan administrator must withhold 20% for taxes and send that money to the IRS. When you reinvest the funds, you must deposit the total original amount from your 401(k) (including the 20% withheld) even if it means using other money from your checking or savings account. A tax advisor can help you organize the paperwork for your year-end tax filing.

Why would someone choose an indirect rollover?

An indirect rollover gives you short-term access to a pool of funds since the money is payable directly to you. You might use this method as a way to grant yourself a short-term, interest-free loan if you return the funds to a retirement account within 60 days. Before you choose this option, you should ensure you will be able to re-deposit the funds to avoid getting hit with taxes and/or penalties.

Next, let’s explore the direct rollover.

What is a Direct Rollover?

A direct 401(k) rollover is a more straightforward option for many investors. With this method, you can ask your qualified retirement plan administrator to directly transfer your funds to an IRA of your choosing. This method is a trustee-to-trustee transfer, where the institution sends the money to the other financial institution.

Alternatively, your 401(k) plan administrator may write a check to the other institution and send it to you to deposit in the new IRA. A qualified retirement plan, or QRP, is a tax-advantaged retirement account that meets IRS rules, including 401(k)s, 403(b)s, and Simple IRAs.

Either way, this rollover process means that the money never enters your hands, which removes the risk of the IRS seeing it as a withdrawal. This makes it safer to avoid any income tax or penalties and to adhere to all distribution rules.

Top IRA Rollover Rules and Limits

You will need to follow several detailed rules to complete your IRA rollover without penalty. Below we outline each policy to help you understand the rollover process.

60-day Rollover Rule

The 60-day rule only applies to indirect rollovers. It states that once you withdraw the funds from one retirement account, you must deposit the funds back into that account or into another retirement account within 60 days. If not, the funds will be subject to income tax and a 10% early withdrawal penalty.

When you consider your rollover funds, we suggest opting for a direct rollover unless you specifically want to use the funds for a short-term loan, as discussed above.

One IRA Rollover Allowed Per Year

The IRS outlines that you cannot make more than one indirect rollover from the same IRA within the same 12-month period. This rule is in place to stop people from exploiting their funds, but there are exceptions depending on the type of IRA account or retirement savings plan. For example, the one-year limit doesn’t apply for:

• Rollovers from traditional to Roth IRAs, or Roth Conversions.
• Trustee-to-trustee transfers to another IRA account, or a direct rollover.
• IRA to QRP rollovers, or vice versa. For example, rolling over a 401(k) to IRA or your Roth 401(k) to Roth IRA to consolidate retirement accounts.
• QRP to QRP rollovers. For example, rolling over your previous 401(k) into your new 401(k).

Various Ineligible Distributions

There are some exceptions to the types of distributions that you can roll over. For an IRA, you can’t roll over: a Required Minimum Distribution or a distribution of excess contributions and those earnings.

For other retirement plans, you can’t roll over Required Minimum Distributions, loans treated as distributions, hardship distributions, and other amounts outlined by the IRS.

Same Property Rule

The same property rule states that you must contribute the same property you withdrew when completing a rollover. For example, if you receive cash from your first retirement account, you cannot use that cash to invest in shares of individual stocks and then roll those over into a new retirement account. Your investment options while the money is in transit between two retirement accounts are restricted.

In Summary

When completing an IRA rollover, ensure that you follow all regulatory guidelines outlined by the IRS, including the 60-day rollover rule, the one-rollover-per-year rule, and the same property rule. Remember that these rules apply to indirect rollovers (where the money enters your hands).

To be safe, you may choose to complete a tax-free direct rollover where the financial institutions complete the transfers, and you don’t have to worry about transferring money yourself.

No matter the option you choose, it’s best to have a trusted partner to assist you with your retirement funds to ensure the process is smooth and successful.

Capitalize can help you find your old 401(k) accounts and roll them over for you to ensure your retirement planning is on track. We partner with our clients to help them complete rollovers with ease. Explore how we can help you with your 401(k) rollover today.