You may need to roll over your retirement plan when changing jobs, becoming self-employed, or adjusting your retirement strategy. When moving your retirement account, the IRS allows a penalty-free and tax-free rollover if the funds enter your new account or plan within a 60-day window. The limit around this timeframe is known as the 60-day rollover rule, and it applies to retirement accounts, including IRAs and 401(k)s.
As you transfer your account or plan, it’s essential to be mindful of this 60-day rollover rule so the IRS doesn’t interpret your withdrawals as IRA distributions, for example. You may owe penalty fees or pay taxes if you don’t follow the guidelines, or if you don’t seek a waiver for the 60-day window rule. That’s why it’s so important to follow all steps within the rollover process with accuracy.
Here, we’ll discuss the 60-day rollover rule, how it works, and the steps to complete your transfers.
What is the 60-day Rollover Rule?
The IRS’s 60-day rollover rule allows rollovers between retirement accounts — free of taxes or penalty fees — as long as you complete the deposit within a 60-day time frame from the withdrawal date. If you do not redeposit the funds into a retirement account within that 60-day window, the IRS considers the funds to be distributed from your retirement account. The funds will thus be subject to potential early withdrawal fees or penalties and possible income taxes.
Be mindful of this rule when transferring or rolling over any retirement account or tax-advantaged retirement accounts, including transferring to or between a Traditional IRA, Roth IRA, or 401(k). The rule also applies when you’re changing to a new financial institution or reinvesting with the same institution. There are two types of rollovers: direct and indirect, and the 60-day rule only applies to indirect transfers.
How the 60-day Rollover Rule Works
With a direct rollover, the account holder requests that the financial institution holding their retirement account moves the funds to another retirement account within the same institution or to another institution’s retirement plan.
Under a direct rollover, the funds never enter your hands, so it’s not considered a withdrawal. The 60-day rollover rule doesn’t apply to transfers of this type, as you never receive the funds directly, and therefore the monies are not subject to taxes or fees. The simplicity of a direct rollover often makes it the preferred way of transferring retirement savings and completing a 401(k) or IRA rollover.
With an indirect rollover, the account holder withdraws the money from their existing retirement account and then reinvests it themselves in a new retirement account. Because the funds enter the investor’s hands, it’s subject to the 60-day rollover rule. In this case, you must reinvest the entire amount (the original 401(k) balance, before tax withholding) into a new or existing retirement account within 60 days to avoid early withdrawal penalties and ordinary income tax.
If the 60-day window passes, the IRS sees the withdrawal as a distribution of funds, and the funds are considered taxable income. More fees may also apply depending on your age and the type of retirement account involved.
It’s also essential to consider the one-rollover-per-year rule connected to the 60-day rollover rule. It states that you can only make one IRA rollover within a 12-month window — with some exceptions. We’ll explore these exceptions later in the article.
Breaking the 60-Day Rollover Rule: The Consequences
If you choose an indirect rollover and don’t re-deposit the entire pre-tax balance to a new retirement account within the 60-day window, you may face various consequences, including:
- Early Distribution Penalties: If you are under the age of 59 1/2, and you withdraw from a retirement account without following the 60-day rule, the funds are classified as an early distribution. This means they’re subject to a 10% penalty, causing you to lose a significant part of your savings. Early withdrawal penalties apply to 401(k), IRA, and Roth IRA accounts.
- Tax Consequences: If you withdraw from a pre-tax 401(k) or an IRA and fail to re-deposit the money into a retirement account within 60 days, the funds are considered a taxable distribution. You’ll need to declare the entire amount as income on your annual tax return
- When you elect an indirect rollover, the financial institution must withhold taxes, so you will almost certainly receive less than your total 401(k) account balance. When you re-deposit the money, be sure to put back the total amount you had in your 401(k) before tax withholding — even when it means you have to use other funds from your bank account. You can correct this difference when you file your tax return for the year.
- Missed opportunities: When you withdraw funds and don’t re-deposit them, you lose out on potential tax-deferred market returns for as long as you keep the money uninvested. This may affect your bottom line in the short term — and over the long run.
Under some circumstances, the IRS outlines it is possible to request a waiver in the event that you do not meet the 60-day rule. Ensure that you meet all requirements before deferring to this option.
The One-Rollover-Per-Year Rule
As mentioned, the one-rollover-per-year rule is a key feature of the 60-day rollover rules. The IRS outlines that an IRA owner can only complete one indirect, tax-free rollover in a 12-month period. This rule tries to prevent account owners from repeatedly cashing out and redepositing their funds as a means to take short-term loans while avoiding taxes. This rule applies to transfers between IRA accounts. There are various exceptions, including:
- Conversion of a Traditional IRA to a Roth IRA: When rollover funds move from a Traditional to a Roth IRA, they’re not subject to the one-rollover-per-year rule because individuals pay taxes on any amounts converted to Roth IRA.
- Trustee-to-trustee rollover: With a trustee transfer, you can ask your former account custodian to write a check to your new account custodian so that you avoid an indirect rollover. In this process, you won’t see the funds come to your bank account, but instead, the funds will transfer directly from one institution to another.
- Rollover to or from a QRP: Qualified retirement plans (QRP) include various account types, including employer-sponsored 401(k), 403(b), or SIMPLE IRA accounts. Exceptions can apply when a rollover takes place directly between a QRP and an existing or new IRA.
Using the 60-day Rollover Rule Safely
Adhering to the 60-day rollover rule can be complex in some cases, so we always recommend that you seek professional help to execute a nontaxable rollover. If you have a financial advisor, they can help you complete the process with additional clarity.
If not, you may consider opting for a direct rollover by contacting your plan administrator, IRA custodian, or brokerage to avoid the 60-day rule altogether. A direct transfer from your 401(k) or IRA account will help you adhere to all FINRA regulations in most cases.
It’s best to play it safe with your rollover process. Working with a partner like Capitalize can ensure you adhere to all 60-day rules and maximize your retirement savings when you roll over your retirement accounts.
Learn more about Capitalize to discover how we can help you follow all regulations, avoid taxes and fees, and efficiently complete your rollover process.