Rollover IRA: How It Works

What is a rollover IRA?

A rollover IRA is a retirement account used to move money from a former employer-sponsored retirement account, such as a 401(k) plan, into an IRA without losing its tax-deferred status ^[0]

Rollover IRAs can also provide a wider range of investment options and low fees, particularly compared with 401(k)s, which can have a short list of investment options and higher administrative fees.

» Ready to get started? See the best IRA providers for a 401(k) rollover.

Why consider a rollover IRA?

If you’re leaving a job with an employer-sponsored retirement plan, you can leave that money where it is, cash out, or roll it over, either into a new employer's retirement plan or an IRA.

One benefit of rolling the money into an IRA is that you can consolidate all of your old 401(k)s, enjoy a broader selection of investments to choose from, and in some cases, you'll have lower administration fees.

Rollover IRA: How to do it in 3 steps

1. Choose an IRA account type

If you have an existing IRA, you can transfer your balance into that account if you want. If you don't have an IRA, you can open one through an online broker or robo-advisor, but first, decide which kind of IRA is right for you.

Traditional IRAs and Roth IRAs are the most popular types of individual retirement accounts. The main difference between them is their tax treatment:

• Traditional IRAs can net you a tax deduction on contributions in the year they are made, but withdrawals in retirement are taxed. If you go this route, you won't pay taxes on the directly rolled-over amount until retirement.

• Roth IRAs don’t offer an immediate tax deduction for contributions. Rolling into a Roth means you’ll pay taxes on the rolled amount, unless you’re rolling over a Roth 401(k). The upside is that qualified withdrawals in retirement are tax-free after age 59½ and you've held the account for at least five years.

Here are things to consider:

• If you want to keep things simple and preserve the tax treatment of a 401(k), a traditional IRA is an easy choice.

• A Roth IRA may be good if you wish to minimize your tax bill in retirement. The caveat is that you'll likely face a big tax bill today if you go with a Roth — unless your old account was a Roth 401(k).

• If you need cash from the rollover to foot the tax bill today, a Roth IRA could open you up to even more tax complications.

» Not sure what to do? A financial advisor may be able to help.

2. Choose a rollover IRA provider

Your choice of rollover IRA provider is not the biggest driver of your portfolio’s growth — that's where your investments come in. However, selecting a rollover IRA provider is critical for keeping fees low and gaining access to the right investments and resources to manage your savings.

The choice often boils down to two options: an online broker or a robo-advisor.

• An online broker may be a good fit if you want to manage your investments yourself. Consider looking for a provider that charges low or no account fees, offers a wide selection of low-cost investments and has a reputation for good customer service.

• A robo-advisor may make sense if you want someone to manage your money. A robo-advisor will choose investments and rebalance your portfolio over time — for a fraction of the cost of a human advisor. Check out our explainer on robo-advisors to see if it’s the right choice for you.

3. Move the money

When you know what type of account you want and where you want to open it, you can start the rollover process. Virtually all rollover IRA providers help you do this — many have “rollover specialists” on staff — but the basics are simple:

• Contact your former employer’s plan administrator, complete a few forms, and ask it to send a check for your account balance to your new account provider.

• The new account provider should give you pretty explicit instructions for how the check should be made out, what information to include — such as your new IRA account number — and where it should be sent.

• Some providers may allow you to wire the funds instead.

The key is the phrase “direct rollover.” That means the money never touches your hands. You can also opt for an indirect rollover, which essentially means you’re withdrawing the money and moving it to the IRA provider yourself, which needs to be completed within 60 days.

» Find the best IRA account for you

Tax implications to know

If you do a direct rollover, you’re good to go. No taxes to consider until you start withdrawing money in retirement.

If you do an indirect rollover — that is, you receive a check made out to you — then mind these rules so you don’t end up owing a big tax bill:

1. How long you have to roll over a 401(k): The 60-day rule

With an indirect rollover, you have 60 days from the date you receive the distribution to get that money into an IRA. If you miss that deadline, the IRS will likely deem this an early withdrawal, which means that in addition to income tax, you could owe a 10% early withdrawal penalty.

2. Taxes are withheld

With an indirect rollover from a workplace retirement plan, usually the check you receive will be for the amount of your 401(k) balance minus 20%. The plan administrator withholds the 20% to pay taxes on your distribution. (If you have a traditional 401(k) and you want to rollover into a Roth IRA, you will need to pay additional taxes.)

To get your money back, you must deposit into your IRA the complete account balance — including whatever was withheld for taxes.

• For example, say your total 401(k) account balance was $20,000 and your former employer sends you a check for $16,000 (that’s the full account balance, minus 20%). Assuming you’re not planning to go the Roth route, you'd need to come up with $4,000 so that you can deposit the full $20,000 into your IRA.

• At tax time, the IRS will see you rolled over the entire retirement account and will refund you the amount that was withheld in taxes.

• You also avoid a 10% penalty. On the other hand, if you had only put $16,000 into the IRA, the IRS would consider that an early withdrawal of the remaining $4,000. You’d owe the early withdrawal penalty on that $4,000 — and, believe it or not, income tax, too.

Can you contribute to a rollover IRA?

Yes, because IRA rollovers are considered separate from your annual contribution limit.

When making your IRA contribution, keep in mind that the limit is $7,000 in 2024 and 2025 ($8,000 if age 50 and older). If you chose a Roth IRA for your rollover, your ability to contribute may be further restricted based on your income. If you choose to make a traditional IRA contribution, your ability to deduct the contribution amount from your taxes each year will also depend on your income amount and if you or your spouse have access to a workplace retirement account.

If you mingle IRA contributions and IRA rollover funds in one account, it may be difficult to move your rollover funds back to a 401(k) if, say, you start a new job with an employer that has a stellar 401(k) plan.

» Dive deeper: See the pros and cons of IRA rollovers.