Rollovers vs Transfers: Avoiding Tax Traps When Changing Employers

Key differences: rollover vs transfer

• Rollover (direct or indirect): A rollover moves money from one retirement account to another. If executed as a direct rollover (trustee‑to‑trustee), the money moves directly and typically triggers no immediate tax. An indirect rollover is when you receive the distribution and then redeposit it into another eligible account within 60 days; indirect rollovers carry more tax risk, withholding, and timing traps. (IRS: Rollovers and Direct/Indirect Rollovers: https://www.irs.gov/retirement-plans/plan-participant-employee/rollovers and https://www.irs.gov/retirement-plans/plan-participant-employee/direct-and-indirect-rollovers)

• Transfer (trustee‑to‑trustee transfer): A transfer moves funds directly between like accounts (for example, IRA to IRA) and is treated as a non‑taxable transaction when handled as a trustee‑to‑trustee transfer. Transfers avoid the 60‑day clock and the withholding complications tied to indirect rollovers.

Why the distinction matters

Small differences in how the money moves can create large tax consequences:

• Withholding: If you take a distribution from a 401(k) and it is paid to you (an indirect rollover), your plan administrator is generally required to withhold 20% for federal income tax. To complete a full rollover and avoid taxation on the distributed amount, you must redeposit the entire distribution — including the withheld portion — within 60 days. That often forces you to come up with the withheld funds out of pocket.

• Taxes and penalties: If you miss the 60‑day deadline or fail to replace the withheld amount, the distribution becomes taxable. If you’re under age 59½, you may also owe a 10% early withdrawal penalty unless an exception applies.

• One‑per‑12‑month IRA rule: The IRS limits indirect (60‑day) rollovers between IRAs to one rollover per 12‑month period for the same funds. This rule does not apply to trustee‑to‑trustee transfers or rollovers from employer plans to IRAs. (See IRS guidance on rollovers.)

Practical examples and numbers

Example 1 — Indirect rollover with 20% withheld:

• You withdraw $50,000 from a company 401(k). Your plan withholds 20% ($10,000) and sends you $40,000.
• To avoid taxes, you must redeposit $50,000 into an eligible IRA or another plan within 60 days. That means you need to find the $10,000 withheld and add it to the $40,000 the plan gave you.
• If you only redeposit $40,000, $10,000 is treated as a taxable distribution (and possibly subject to the 10% penalty).

Example 2 — Direct rollover (recommended):

• You request a direct rollover from your old employer’s plan to a new employer plan or an IRA. The plan administrator moves funds directly; you never touch the check. No withholding, no 60‑day timing risk, and no immediate tax.

Example 3 — Rollover to Roth IRA (conversion):

• Rolling a pre‑tax 401(k) or traditional IRA into a Roth IRA is a taxable conversion. You’ll owe ordinary income tax on the converted amount in the year of conversion, though no 10% penalty applies solely because it’s a conversion. Consider tax timing and your tax bracket before converting.

When to choose each option

• Direct trustee‑to‑trustee transfer: Use this when moving funds between like accounts (IRA to IRA) or when your receiving plan accepts direct rollovers. This is the simplest, safest, and most tax‑efficient method.

• Direct rollover from employer plan to IRA or new employer plan: Use this if you want to consolidate or prefer IRA investment choices. Ask your plan administrator for a direct rollover.

• Indirect rollover: Only use if unavoidable. If you receive the distribution, act quickly: deposit the full distribution, including any withheld taxes, into a qualified account within 60 days.

• Roll into a Roth IRA (Roth conversion): Choose this intentionally for tax‑diversification. Be prepared to pay income tax on pre‑tax amounts converted.

Step‑by‑step checklist when changing employers

1. Inventory your accounts: list balances, account types (traditional 401(k), Roth 401(k), IRA), plan rules, and fees.
2. Confirm the new employer’s plan accepts rollovers. Not all plans accept incoming rollovers.
3. Compare investment options, fees, and creditor protection between keeping the old plan, rolling to the new plan, or rolling to an IRA. See our guide on Retirement Plan Portability for consolidation considerations: Retirement Plan Portability: Moving Pensions, 401(k)s, and IRAs.
4. Request a direct rollover/trustee‑to‑trustee transfer whenever possible to avoid withholding and the 60‑day deadline.
5. If you must take a distribution (indirect rollover), immediately redeposit the full amount within 60 days and document the transaction.
6. For conversions to Roth, estimate and set aside funds to cover the tax bill for the conversion year.
7. Keep written confirmation from plan administrators and new custodians; keep records of the rollover/transfer for tax reporting and audits.

Common traps and how to avoid them

• Mistake: Treating a transfer and an indirect rollover as the same thing. Remedy: Ask the administrator to perform a trustee‑to‑trustee transfer and obtain written confirmation.

• Mistake: Missing the 60‑day deadline. Remedy: Use direct rollovers when possible; if you receive funds, set an automated reminder and work with your tax professional immediately if you miss the deadline (there may be limited relief options).

• Mistake: Forgetting about withholding. Remedy: Understand the 20% withholding rule for distributions from employer plans and plan accordingly.

• Mistake: Rolling pre‑tax funds to a Roth without planning. Remedy: Model the tax impact and, when appropriate, stagger conversions across years to manage the tax bite.

What the IRS says

The IRS explains the difference between direct rollovers and indirect rollovers, the 60‑day rollover rule, and withholding requirements on employer plan distributions. Read IRS guidance: “Rollovers” and “Direct and Indirect Rollovers” (IRS.gov).

Related resources on FinHelp

• For a quick primer on IRAs, see our page: Individual Retirement Arrangement (IRA).
• For help weighing consolidation choices when you change jobs, read: Retirement Plan Portability: Moving Pensions, 401(k)s, and IRAs.
• For 401(k)‑specific rollover steps and checklists, see: 401(k) Rollover.

Real client insight (from practice)

In my practice working with over 500 clients, the single biggest error I see is assuming a distribution mailed to the participant is the same as a direct rollover. One client received a check for a 401(k) distribution, redeposited the net amount, and assumed he’d avoided taxes. Because the plan withheld 20%, he was short and ended up with a taxable distribution and a surprise tax bill. The fix would have been a direct rollover or redepositing the full gross amount within 60 days.

FAQ (concise answers)

• What if I miss the 60‑day deadline? You’ll likely owe income tax on the distribution and possibly a 10% early‑withdrawal penalty if under 59½. Consult a tax professional; there are rare exceptions and relief provisions.

• Can I roll a 401(k) directly to a Roth? Yes—this is a Roth conversion and is taxable in the conversion year.

• How often can I roll IRAs? The IRS generally limits indirect IRA‑to‑IRA rollovers to one per 12‑month period. Trustee‑to‑trustee transfers are not subject to this limit.

Final takeaways

• Always favor direct, trustee‑to‑trustee transfers to avoid withholding and timing risks.
• Understand that rolling pre‑tax funds into a Roth creates a tax bill; plan ahead.
• Keep thorough records and confirm the receiving custodian has properly titled and received the assets.

Professional disclaimer: This article is educational and not personalized tax or investment advice. Rules may change; consult the IRS website (https://www.irs.gov/retirement-plans/plan-participant-employee/rollovers) or a qualified tax advisor for decisions about your situation.

Authoritative sources: IRS — Rollovers and Direct/Indirect Rollovers (IRS.gov). Additional resources include FinHelp guides linked above.