Why roll over retirement accounts?

Rolling over retirement accounts can simplify your investment lineup, reduce fees, consolidate statements, and make it easier to follow a single withdrawal strategy in retirement. Done correctly, a rollover preserves the tax-deferred status of your savings; done incorrectly, it can trigger ordinary income tax, withholding, and early withdrawal penalties.

In my practice working with clients on retirement transitions, the most common avoidable errors are using an indirect rollover by mistake, not replacing withheld amounts, or treating a pre‑tax-to‑Roth move as tax-free. The technical rules are straightforward once you know where the traps are.

(Authoritative resources: IRS — “Rollovers of Retirement Plan Balance” and CFPB — “What is a rollover?”)

Types of rollovers and tax consequences

Direct rollover (trustee‑to‑trustee transfer)

A direct rollover sends money straight from Plan A to Plan B without you receiving a check. This is the cleanest option: no mandatory withholding, no taxable distribution, and no 60‑day clock. I recommend direct rollovers for nearly every client moving funds between employer plans and IRAs when the receiving plan will accept the transfer.

Why use it: avoids the common withholding and timing pitfalls; keeps investments in tax-advantaged status (IRS guidance).

Indirect rollover (you receive the distribution)

An indirect rollover occurs when your plan distributes funds to you and you have to deposit them into another eligible plan within 60 days. If the distribution is from an employer plan (like a 401(k)), the payer usually withholds 20% for federal income tax on taxable amounts. To avoid tax on the withheld amount you must replace that 20% from other sources when completing the rollover within 60 days.

Key risks:

  • Miss the 60‑day deadline and the distribution becomes taxable (and possibly subject to a 10% early withdrawal penalty if under 59½).
  • If the plan withheld 20% and you don’t make up the withheld portion, the withheld amount counts as a taxable distribution.

(See IRS rollover guidance and Pub 590.)

Roth conversions and mixed-basis rollovers

Rolling pre‑tax money (traditional 401(k) or IRA) into a Roth IRA is a conversion, not a tax-free rollover. That conversion is a taxable event: you’ll owe income tax on the pre-tax portion converted. If your account contains after‑tax (basis) money, the taxable amount will be reduced by that basis — proper reporting matters (Form 1099‑R, Form 8606).

If you’re considering converting part or all of a pre‑tax account to Roth, plan for the tax bill and consider whether partial conversions across years make sense.

Special cases: inherited accounts, pensions, and employer plans

Inherited IRAs, certain pension plans, and some non‑qualified deferred compensation arrangements have special rollover and distribution rules. You can’t generally roll an inherited IRA into your own IRA. Always check plan documents and IRS guidance before moving these funds.

Practical, step‑by‑step checklist to avoid tax surprises

  1. Decide whether the receiving account will accept the rollover. If you expect to keep funds in a new employer plan, confirm eligibility and investment options.
  2. Prefer a direct rollover (trustee‑to‑trustee). Ask the old plan administrator to send funds directly to the new custodian.
  3. If you must use an indirect rollover, understand the 60‑day rule and the 20% withholding risk. If the plan withholds, replace that withheld amount from other funds to complete a full rollover.
  4. For Roth conversions, estimate the taxable income and plan your withholding or estimated tax payments to avoid underpayment penalties.
  5. Keep documentation: confirmation letters, statements showing the transfer, and Forms 1099‑R and 5498 for tax reporting.
  6. Check for early distribution penalties: if you are under 59½ and take a distribution that is not rolled over, you may owe a 10% penalty (IRS rules on early distributions).

Sample wording to give plan administrators when requesting a direct rollover:

“Please initiate a trustee‑to‑trustee rollover. Make the distribution payable to [Receiving Custodian/FBO Participant name] and send to [Receiving Custodian details].”

Tax reporting you’ll see

  • Form 1099‑R: Issued by the distributing plan. It reports the distribution and whether taxes were withheld. Even if the full amount was rolled over, you’ll still get a 1099‑R; you report the rollover on your tax return and exclude the amount if it was rolled over.
  • Form 5498: Issued by the receiving IRA custodian showing rollovers received. It may arrive after tax filing season, but it documents the transfer to the IRS.

Keep both forms with your records. Your tax preparer will use Form 1099‑R and, if applicable, Form 8606 (after‑tax basis and Roth conversions) to prepare an accurate return.

(IRS forms and Pub 590 explain reporting rules.)

Common mistakes and how to avoid them

  • Relying on an indirect rollover without understanding withholding: use direct rollovers when possible.
  • Forgetting the one‑per‑year indirect IRA rollover rule: you may only make one indirect IRA‑to‑IRA rollover in any 12‑month period (trustee transfers are exempt). This rule can create tax surprises if you perform back‑to‑back transfers mistakenly treated as indirect rollovers (IRS Pub 590‑A).
  • Treating a rollover as a substitute for understanding RMD rules: required minimum distribution rules (affected by SECURE and SECURE 2.0 legislation) can limit rollover options once RMDs must begin.
  • Overlooking plan paperwork: some employer plans don’t accept rollovers of after‑tax contributions, and some require paperwork that can delay a transfer.

Examples that illustrate the tax impact

Example A — Direct rollover (clean outcome):
You leave Employer A with a $100,000 401(k). You request a direct rollover to an IRA. The plan transfers $100,000 to your IRA; you receive no check and no withholding occurs. Result: no taxable income, no withholding, and funds stay tax‑deferred.

Example B — Indirect rollover with withholding (costly unless replaced):
Employer B cuts you a $100,000 distribution and withholds $20,000 for taxes. You have 60 days to roll over $100,000 to an IRA. To avoid tax on the $20,000 withheld, you must add $20,000 from other funds when depositing. If you only roll over the $80,000 you received, the $20,000 withheld is treated as a distribution and is taxable (and could be subject to the 10% early withdrawal penalty).

Example C — Mistaken Roth conversion:
You roll $50,000 of pre‑tax 401(k) money directly into a Roth IRA thinking it’s a tax‑free rollover. It’s a conversion: you owe income tax on the $50,000 in the year of conversion.

When to get professional help

Talk to a financial planner or tax advisor when:

  • Your rollover involves pre‑tax and after‑tax (basis) money that needs pro‑rata allocation.
  • You plan a partial Roth conversion and want to manage the tax impact across years.
  • You’re dealing with inherited accounts, pensions, or plans with unusual rules.

Internal resources on our site that explain related topics in detail:

Final action plan (quick reference)

  1. Confirm the receiving account accepts rollovers.
  2. Request a direct, trustee‑to‑trustee transfer whenever possible.
  3. If you receive a distribution, make the full rollover within 60 days and replace any withheld taxes from other funds.
  4. Plan Roth conversions with a tax strategy in mind.
  5. Save all 1099‑R and 5498 forms and get professional advice for complex situations.

Professional disclaimer

This article is educational only and does not constitute tax, legal, or investment advice. Rules for distributions, rollovers, Roth conversions, and required minimum distributions change; confirm current guidance from the IRS (see links above) and consult a qualified tax advisor or financial planner for advice tailored to your situation.

Authoritative sources