Moving retirement funds from one retirement account to another is a common practice. For example, many people tend to rollover their 401(k) to an IRA once they leave an employer. Likewise, many complete a transfer or rollover when switching to a self-directed IRA to get access to alternative investments.

Rollovers are the most streamlined option when switching money from different accounts, such as a 401(k) to an IRA. There are two types of rollovers:  direct and indirect. Each respective rollover type may offer separate benefits for different investors.

If you choose an indirect rollover, you will be subject to what is known as the IRA 60-day rollover rule. This guide will explain that rule and what you need to know to avoid a penalty.

What Is a Rollover?

A rollover is a movement of funds from one eligible retirement account to another. For instance, a rollover can move funds from a 401(k) to an IRA or a standard IRA to a self-directed IRA.  Generally, rollovers are not subject to taxation, as long as the transfer is completed within 60 days.

Rollovers are used for two accounts that are structured differently, such as rolling over from a 401(k) to a Traditional IRA, while transfers only move money from one institution to another using the same account type (Traditional IRA to Traditional IRA).

Direct vs. Indirect Rollovers?

When completing a rollover, there are two specific types you can choose from: direct and indirect rollovers.

A direct rollover is when the funds are moved directly from one qualified account to another. The account holder never takes possession of the money. This is often the easiest way to complete a rollover and negates the potential risk of taxes and penalties.

An indirect rollover is when the account holder withdraws and takes active possession of the funds, intending to redeposit them in the new account. Indirect rollovers must be completed within 60 days or the withdrawn amount may be subject to taxes and penalties.

Why Use an Indirect Rollover?

Direct rollovers are often the easiest way to transfer funds, but investors can benefit from an indirect rollover if they need access to short-term liquidity. For example, under the 60-day rule provided by the IRS, account holders can take out their funds they are transferring as a lump sum. This allows investors to potentially move funds around or make short-term investments, only requiring them to return the funds to the new account within 60 days to avoid a hefty penalty.

What Is the 60-Day Rollover Rule?

The 60-day rollover rule is specific to indirect rollovers. It states that funds withdrawn from a qualified retirement account must be deposited into another qualified retirement account within 60 days.

If you don’t deposit the amount withdrawn into another qualified retirement account within 60 days, a 10% early distribution penalty will be applied unless you’ve reached the age of 59 ½. If the account is designated a Traditional IRA or 401(k), you must also pay income tax on the withdrawal. Roth account withdrawals are not subject to income tax, as contributions are made with after-tax dollars.

Warning: If you are moving money indirectly from a 401(k) to another qualified account, such as an IRA, IRS rules state that “the taxable distribution paid to you is subject to a mandatory federal withholding of 20%.” The 20% is withheld even if you intend to deposit the sum within 60 days.

If you want to avoid taxes on the 20% withheld, you’ll need to come up with and deposit the difference within 60 days. This withholding can be avoided with a direct rollover.

Avoiding 60-day rule penalties

There are some circumstances under which you may be able to avoid a penalty if the funds are not deposited within 60 days. You can request a waiver under certain circumstances, such as:

• If you followed the required steps to deposit the funds within 60 days but missed the deadline due to an error by the financial institution.
• You can’t complete the rollover due to an extenuating circumstance, such as a death, severe illness, hospitalization, postal error, incarceration, or restriction placed on you by a foreign country.

When to Use an Indirect 60-Day Rollover?

One of the primary reasons you may choose to use an indirect rollover is if you need access to the withdrawn amount for a short period, such as a short-term loan. In this case, you can use the funds without penalty as you see fit as long as you can deposit the full amount within the 60-day period.

An indirect rollover may also be beneficial if you want to take custody of the funds but need additional time to determine which custodian, financial entity, or retirement plan is best for your needs.

Remember, there are risks associated with a 60-day rollover that are not present for a direct rollover. Primarily, you may need to pay a penalty and taxes if you miss the deadline and aren’t eligible for a waiver.  Additionally, you miss out on compound interest and potential growth while the funds are in your possession as opposed to a qualified retirement account.

Warning: If you are moving funds from a 401(k) to an IRA, the plan administrator will withhold 20% of the amount.

Penalties for Not Rolling Over the Full Amount

If you choose an indirect rollover and do not roll over the full withdrawal, the amount that was not redeposited will be subject to income tax. If you are under age 59 ½, that amount will also be subject to penalty.

FAQs

How does a 60-day rollover differ from a direct IRA transfer?

When you use a 60-day rollover, you take possession of the withdrawn funds and have 60 days to redeposit them into the new account. Failure to comply with the 60-day rule can result in taxes and penalties.

If you choose a direct transfer, the custodian or financial institution manages the transfer, moving funds from one account to another. You never take possession of the funds.

A direct IRA transfer is typically preferred as it removes the risk of unnecessary taxes and penalties.

How many times can I do a 60-day rollover in a year?

You can complete one 60-day rollover within a 12-month period. Direct rollovers are not subject to the 12-month rule and can be completed as frequently as necessary.

How do I report a 60-day rollover to the IRS?

When you complete a  60-day rollover, your custodian or financial institute that held the original account will issue a 1099-R. Once you receive the form, you can use it to report your 60-day rollover on IRS Form 1040.

If you’re not sure how to report the rollover or have questions, always consult your tax professional for guidance. We have also listed tax information that SDIRAs need to be aware of, which includes information about rollovers and transfers.