A rollover individual retirement account (IRA) is established with funds that are rolled over from another IRA or 401(k). Rollover IRAs are used by investors who want to change IRA providers. If you want to change providers or get more investment options, an IRA rollover is a free process that’s ideal for getting access to more investment options.
What a Rollover IRA Is
A rollover IRA is like a traditional IRA except it’s established using an IRA rollover. A rollover is a process that lets investors move money from one custodian to another. Most people do rollovers after leaving a company that had a 401(k) instead of withdrawing money because they offer wider investment options and lower costs.
Employees who are eligible for a rollover IRA can do one rollover in a 12-month period — no matter how many IRAs or 401(k) accounts they have. According to IRA rollover rules, completing a rollover is a simple process. There are two ways to do a rollover — a direct transfer between custodians or by having your current custodian send you a check and completing the rollover yourself within 60 days.
If you do an IRA rollover properly, there is no cost except for any commissions on investments that you buy in your new account. Once your rollover IRA is set up, you can contribute to it the same way you would to a traditional IRA, provided that you’re eligible for traditional IRA contributions.
While you can contribute to a rollover IRA once it’s set up, depositing new contributions into a rollover IRA will prohibit you from rolling your IRA into another 401(k) in the future. This may restrict what you can do with your rollover IRA in the future. For more information, check out the 401(k) Rollover to IRA section below.
Who a Rollover IRA is Right For
Before doing an IRA rollover, it’s important to ensure that you meet Rollover IRA Eligibility criteria outlined below. However, if you’re eligible, there are certain cases when a rollover IRA is especially beneficial for investors who want to change providers or have left a company that had a 401(k) and want more investment options.
Some cases when a rollover IRA may be appropriate include:
- Separated from employment: One of the most common reasons for doing an IRA rollover is when someone leaves a company that provided retirement benefits like a 401(k); by using a rollover IRA, an account holder can move money out of their former employer’s retirement plan and gain access to new investment options of their choosing — sometimes at a lower cost
- Want to lower costs: An IRA rollover is a free process that lets you change account providers and possibly lower account costs — the only cost is for the investments you buy in your new account
- Changing financial advisors: If you’re moving to a new financial advisor, they may use a different custodian and require you to use an IRA rollover to move your money to their firm
- Seeking new investment options: Using an IRA rollover to move money to a new custodian and give you access to a wider set of investment options
- Need a 60-day loan: Although it’s never recommended, some people use IRA rollovers as a way to take a 60-day interest-free loan from their retirement assets; however, funds have to be replaced in time to complete the rollover within 60 days
- New small business owner: You can use an IRA rollover to set up a new retirement plan for your small business; you may need to do a rollover if you decide to use a Rollover for Business Startups (ROBS) to help finance your new business
“The ability to rollover retirement assets can lead to a simpler retirement strategy with more control over investment choices. If an individual has had multiple employers throughout their working career, he or she most likely have multiple retirement accounts. It can become easy to lose track of those accounts. Rolling those accounts over to another IRA or potentially even a Roth IRA can drastically simplify an overall portfolio. While funds are in a 401(k)/403(b), investment options are limited to what the company has approved. Once a rollover is completed, a client has access to a much larger pool of investment options.” — Ben Koval, Financial Planner, Decker Retirement Planning
IRA Rollover Rules
To establish and use a rollover IRA without incurring unwanted taxes or penalties, it’s important to follow certain IRA rollover rules. While some of these rules limit how many rollovers you can do in a year or restrict rollover IRA eligibility, other rules limit what you can do with a rollover IRA after it’s established.
The six main IRA rollover rules are:
1. Limit of One IRA Rollover per Year
The first thing to understand about IRA rollovers is that you are only allowed to do one rollover in a 12-month period, regardless of how many IRAs you own. However, this rule does not apply to traditional to Roth IRA conversions or direct transfers between trustees.
For many people, this rule doesn’t present much of a problem. However, violation of the IRS’s one-rollover-per-year rule can cause the extra rollovers to be treated as taxable distributions. You may also be assessed a 10 percent penalty, and your rollover funds could be treated as excessive contributions taxed at 6 percent per year as long as they stay in your rollover IRA.
2. Must Meet Rollover IRA Eligibility Requirements
To complete an IRA rollover, you must not have done another rollover in the past 12 months. You must also be eligible to move money from your current retirement account. This typically means that you must have separated from employment at the company providing your retirement benefits and are no longer eligible to participate in their retirement plan.
While this rule can seem relatively straightforward, there are a number of workarounds that employers use to help plan participants move money out of their retirement plan. Some employers will temporarily lay-off an employee, which technically separates them from employment and allows them to initiate an IRA rollover.
However, there are also a few exceptions to this rule. For example, some retirement plan documents permit “in-service distributions” under certain circumstances, which may allow a current employee to complete an IRA rollover. Employees may also be eligible for a rollover IRA if their company is acquired or reorganized.
3. IRA Rollover Must Be Complete within 60 Days
All funds for an IRA rollover must be transferred to the new custodian within 60 days of when the check is issued by the previous custodian. If your rollover isn’t completed in that time, the funds will be treated as a distribution that’s taxable as ordinary income. If you are age 59 1/2 or younger and ineligible for IRA withdrawals, you will also be assessed a 10 percent early distribution penalty.
If you’re eligible for IRA distributions without penalty and fail to complete a rollover within 60 days, there’s no penalty. You ,have to pay taxes on the funds you intended to roll over the same way you would for any distribution.
4. Only Allowable IRA Investments Can Be Used
In a rollover IRA as with other types of retirement accounts, investors must limit themselves only to IRS-allowed investments. This means that there are only a few things that you’re not allowed to hold in an IRA including art, rugs or collectibles.
While most IRA holders confined their investments to stocks, bonds, mutual funds, exchange-traded funds (ETFs) and other tradable securities, there are other investments that are available. For more information on what investments you can hold in an IRA, be sure to check out our ultimate guide to Self-Directed IRAs.
5. Employers Must Withhold 20% of the IRA Rollover for Taxes
This IRA Rollover rule only applies to employers. Whenever a participant in an employer-sponsored retirement plan requests a rollover from their custodian, 20 percent of the amount of the rollover must be withheld for federal income taxes — even if the employee intends to roll their funds over to a new custodian.
Federal income tax withholding for IRA rollovers is typically handled by the plan custodian or administrator, but according to IRA rollover rules, it’s up to employers to ensure that taxes are withheld. Once the employee completes their rollover, they can get back the taxes that were withheld.
If an employer fails to withhold 20 percent on an eligible IRA rollover, they may be required to pay any taxes that result from the rollover. However, withholding is not required for direct transfers between custodians. This is another reason why many people do trustee-to-trustee transfers instead of traditional 60-day IRA rollovers.
6. Don’t Exceed Rollover IRA Contribution Limits
One concern that’s commonly expressed when an investor is deciding whether to do a rollover is “Can I contribute to a rollover IRA?” The answer is yes — you can contribute to a rollover IRA if you meet traditional IRA eligibility requirements. However, to contribute, you must meet certain IRA income limits.
How much you can contribute to a rollover IRA depends on your income and whether you’re eligible for a retirement plan at work. However, if you’re eligible for a retirement plan at work but your income doesn’t exceed certain thresholds, you may be able to contribute to a rollover IRA.
To determine your rollover IRA contribution limits, check the IRA rules for accounts including:
Another item to be aware of with rollover IRA contributions is that this may restrict your ability to move your account in the future. If, for example, you do a 401(k) rollover to IRA and later contribute to that rollover IRA, you won’t be able to roll your IRA back into a 401(k) at some point in the future. This is covered further in the 401(k) Rollover to IRA section below.
“A direct transfer going from your 401(k) to your IRA is the best and easiest option. You can get a check and then use the 60-day period to put the money into a qualified account but use caution. Some states require a tax to be withheld. You can only do one rollover per year when doing it this way. Most plans allow a direct transfer at age 59 1/2 even if you are still working, which can allow you to move the bulk of your retirement dollars to an IRA and still contribute to a 401(k).” — Mark Henry, CEO, Alloy Wealth Management
IRA Rollover Limits
There’s no limit on how much investors can rollover from employer-sponsored retirement plans into IRAs. However, investors are limited to just one IRA rollover in a 12-month period. They’re also limited in how much they can contribute to a rollover IRA after the rollover is complete, but these contribution limits can vary based on several factors.
The two IRA rollover limits include:
- IRA rollover contribution limits: Up to $6,000
- IRA rollover frequency: 1 rollover per 12-month period
As detailed in the IRA Rollover Rules section above, investors are limited to one rollover in a 12-month period regardless of how many IRAs they own. However, this limit does not apply to direct transfers or Roth IRA conversions.
If you aren’t eligible for a retirement plan through your work you can contribute up to $6,000 to a rollover IRA each year, plus an additional $1,000 in catch-up contributions if you’re age 50 or older — the same contribution limits as a traditional IRA.
If you’re eligible for an employer-sponsored plan, you may not be able to contribute up to rollover IRA limit or even at all. For more information be sure to our ultimate guide to traditional IRAs.
Rollover IRA Deadlines
There are two rollover IRA deadlines to know if you intend to use an IRA rollover. A rollover IRA can be established anytime (if you’re eligible) because the account is being started with previous contributions. However, there is a 60-day window in which rollovers must be completed and a deadline for new rollover IRA contributions.
The two primary rollover IRA deadlines are:
1. Complete IRA Rollover Within 60 Days
Once you begin an IRA rollover, you must complete your rollover within 60 days of your previous custodian issuing your check. If you fail to complete your rollover within the 60-day window, your rollover will be treated as a taxable distribution. If you’re under 59 1/2, you will also be assessed a 10 percent early distribution penalty.
2. Can Make IRA Contributions Until Your Tax-filing Deadline
Eligibility requirements for rollover IRA contributions are the same as traditional IRAs. If you are eligible to contribute to your rollover IRA for a given year, you may contribute to your account up until your tax-filing deadline for that year.
Rollover IRA Contribution Deadlines
Best Rollover IRA Providers
You can open a rollover IRA at banks, brokerage firms or mutual fund companies. When considering providers, it’s best to consider several factors based on your individual investment strategy and other needs. Some providers stand out with cost-efficient investment options, low-cost trading, individual guidance or other financial services in addition to rollover IRAs.
Five of the best rollover IRA providers are:
With more than $5 trillion under management, Vanguard is well-known as a leading provider of professionally-managed, cost-efficient mutual funds and ETFs. Vanguard is the best rollover IRA provider if you want to focus on low-cost, passive investing in your rollover IRA. It offers more than 100 mutual funds to choose from, including several funds that can focus investments in specific sectors or asset classes.
Fidelity’s primary offerings include brokerage and investment advisory services, but it also has a retail bank and a number of offices around the country where you can get individual guidance. Fidelity is the best rollover IRA provider for account holders who have other accounts or banking needs and may benefit from some of Fidelity’s other offerings.
TD Ameritrade has retail banking operations in the United States and Canada. The brokerage side of the firm also has a strong online-trading platform for investors who want to trade stocks and bonds. If you want to actively trade in your rollover IRA and or may want to get individual guidance at one of its offices around the country, you should consider working with TD Ameritrade.
Charles Schwab has a well-established firm that provides securities brokerage, advisory and retail banking services. It can now help not only with rollover IRAs and other types of retirement accounts but also with banking and other financing needs. If you’re a small business owner, Charles Schwab is the best rollover IRA provider for additional banking services to help you grow your business.
E-Trade is the best rollover IRA provider if you want to day-trade in your account. While frequent trading is not recommended in a rollover IRA, E-Trade’s cost structure is better than many alternatives for account holders who plan to place a lot of trades. If you decide later to change to passive investing, E-Trade offers a wide range of mutual funds and ETFs.
How to Establish a Rollover IRA in 6 Steps
The typical way of doing an IRA rollover is by transferring funds directly from one custodian to another. However, the traditional way of establishing a rollover IRA is to initiate a request with your current retirement account provider, have them mail you a check, and then deposit those funds with your new provider within 60 days.
The six steps to complete an IRA rollover are:
1. Confirm IRA Rollover Eligibility
Before beginning an IRA rollover you need to make sure that you’re eligible. To be eligible, you can’t have done a rollover within the past 12 months. If you’re moving money from an employer-sponsored retirement plan, you typically need to have separated from employment with the company that sponsored the plan.
For more information on eligibility requirements for an IRA rollover, be sure to revisit the IRA Rollover Rules section above.
2. Identify a New Custodian
Once you’ve confirmed that you’re eligible for an IRA rollover, it’s a good idea to find a new provider that you’ll be rolling over funds to. Once you begin your rollover, you’ll only have 60 days to finish it, so it’s important to have things lined up before you begin.
3. Complete Application with New Custodian
After you’ve identified a new provider to hold your rollover IRA, you should be able to go ahead and complete the account application process. You will need an account in which to deposit your funds, completing your IRA rollover. Setting up your account before starting the rollover process will help ensure that the funds are deposited within the 60-day window.
4. (In Some Cases) Notify Current Custodian
If you’re moving money from a 401(k) or other retirement plan, you may need to notify your current custodian that you intend to do a rollover. That will allow your current provider to liquidate investments in your account in preparation for sending you a check for the value of your account.
5. Initiate Rollover
Once you have everything set up with your new custodian, you can initiate the rollover process. You may be able to do this by having your new custodian initiate a direct transfer to move your funds directly from your current provider. Otherwise, you can request that your current custodian mail you a rollover check.
6. Deposit Funds
If you initiated your rollover using direct transfer, your funds should be deposited automatically in your new account within a few days. If you used a traditional check for your IRA rollover, you need to deposit your funds in your account with your new custodian within 60 days from the date the check is issued.
Failure to deposit funds on time will mean your rollover funds will be taxable as income. If you’re less than age 59 1/2, you’ll also have to pay a 10 percent early distribution penalty. If you complete your rollover late, in addition to taxes and penalties your rollover funds may be treated as excessive contributions and taxed 6 percent each year they remain in your rollover IRA.
The traditional process of doing an IRA rollover can be somewhat cumbersome and leave account holders with a lot to manage. As a result, most people don’t use a traditional 60-day rollover process to establish a rollover IRA unless they want access to their retirement funds for 60 days as part of 401(k) business funding. Instead, they use direct transfers.
In a direct transfer, account holders who want to move money work through their new provider rather than the old one. When setting up their new account, they have the new custodian initiate a transfer request, which moves the account directly from the old custodian. Using a direct transfer, the old custodian doesn’t always even have to sell all the investments within an account — they can sometimes transfer the account with the current portfolio intact.
401(k) Rollover to IRA
A 401(k) rollover to IRA involves rolling funds from a 401(k) account into an IRA and is the most common type of IRA rollover. These rollovers are most often used when someone has retired or left an employer and wants to take their account out of an employer 401(k) plan to get access to more investment options available within the plan.
The first thing to know about a 401(k) rollover to IRA is that not everyone can do it. If you’re still working for the company, for example, you probably can’t roll money out of your 401(k) into an IRA. However, you may be eligible for a rollover IRA if your employer’s plan allows in-service distributions, if you get a short-term layoff or if your company is acquired or reorganized.
Investors should also be aware that certain actions taken after a 401(k) rollover to an IRA account can have an impact on the long-term flexibility of your account because the IRS has rules prohibiting co-mingling of certain retirement funds.
If, for example, you do a 401(k) rollover to IRA and later contribute to your rollover IRA (as you would to a traditional IRA) or if you combine that rollover IRA with assets from another IRA, you may be limited in what you can do with your rollover IRA in the future. If you joined a new company, you would not be able to roll that account into your new 401(k).
Rollover IRA vs. Traditional IRA
A rollover IRA is very similar to a traditional IRA and gets almost identical tax treatment. However, there are key differences between a rollover IRA and a traditional IRA including how they’re established. While a traditional IRA is typically established with new contributions or direct-transfer between custodians, a rollover IRA starts by rolling funds from another retirement account.
Once an IRA rollover is completed, however, the resulting account is very similar to a traditional IRA. They can utilize the same investment options and providers with the same contribution limits and eligibility requirements. While rollover IRAs have unique rules for setup, the rules and deadlines that apply after an account are established are the same as traditional IRAs.
However, sometimes account holders do a direct transfer (instead of a traditional IRA rollover), and their account is established as a traditional IRA or a rollover IRA. This can cause problems in the future. If they ever want to roll IRA into 401(k) with a new employer, they may not be allowed if their account is mislabeled as a traditional IRA. They may also be prohibited from rolling their IRA into a new 401(k) if they ever make contributions to their rollover IRA.
Partial IRA Rollover
A recent study from the Investment Company Institute found that more than 80 percent of those surveyed had rolled over their entire balance in their most recent IRA rollover. However, one of the unique things about an IRA rollover is that you do a partial IRA rollover to move just part of an account. However, you must still meet eligibility requirements and follow IRA rollover rules.
One of the advantages of partial IRA rollovers is that it can help you spread out accounts with different providers. Aggregate costs for managing two accounts rather than one may be slightly higher than having just one account and having multiple accounts doesn’t increase your IRA contribution limits. However, having multiple accounts at different providers can allow you to diversify across different investment options.
Roth IRA Rollover
If you have a Roth IRA or Roth 401(k) you can do an IRA rollover in almost the same way as traditional 401(k)s, IRAs or other tax-deferred accounts. The biggest difference with a Roth IRA or Roth 401(k) is that a rollover must go into another after-tax Roth account.
In other words, you can’t do an IRA rollover to roll money from a Roth IRA into a traditional IRA. Many of the same IRA rollover rules apply to Roth IRA rollovers including the limit of one rollover per 12-month period.
However, using a Roth conversion, investors may have the option of rolling money from a traditional 401(k) or another tax-deferred account into a Roth IRA. A Roth IRA conversion requires paying taxes that were deferred when they contributed to a traditional 401(k) or IRA and rolling those assets into a Roth account.
Using a Roth IRA conversion requires investors to follow strict rules like paying taxes and completing the conversion within 60 days. For investors who want to roll money from a tax-deferred account into a Roth IRA, it’s a good idea to work with an accountant or licensed financial advisor. Otherwise, investors may end up paying taxes on the converted amount and/or a 10 percent penalty.
Rollover IRA Frequently Asked Questions (FAQs)
If you still have questions after reading this ultimate guide, here are some of the most frequently asked questions about rollover IRAs. If you still don’t see an answer to your question, feel free to join the conversation in the comments below or visit the FitSmallBusiness Forum and post your question there.
Are IRA Rollovers Taxable?
No, IRA rollovers are not taxable events unless you fail to complete your rollover within a 60-day window. In that event, your rollover is treated as a statutory distribution, and you may be subject to a 10 percent early distribution penalty if you’re younger than age 59 1/2. Although not taxable, IRA rollovers must be reported to the IRS in annual tax filings.
Can a Rollover IRA Be Converted to a Roth IRA?
Yes, a rollover IRA can be converted to a Roth IRA using a Roth IRA conversion. A Roth IRA conversion requires following certain rules and paying the taxes on the account value — taxes that were initially deferred when contributions were made.
Can I Withdraw Money from a Rollover IRA?
Yes, if you can withdraw money from a rollover IRA just like any other IRA or 401(k). However, to avoid rollover IRA distribution penalties, you need to be at least age 59 1/2 when you take distributions from a rollover IRA or meet certain IRS hardship withdrawal criteria.
How Much Tax Is Paid on IRA Withdrawals?
When you take distributions from an IRA or other tax-deferred retirement account, withdrawals are taxed as ordinary income. However, if you aren’t yet age 59 1/2 or older when you make a withdrawal or meet certain hardship criteria, distributions are subject to an additional 10 percent penalty.
The Bottom Line
A rollover IRA is a useful tool for investors who have left a job that provided retirement benefits or want to change IRA custodians to access new investment options. While IRA rollovers can also be used to provide short-term 401(k) business funding up to 60 days, this is extremely risky and should only be undertaken after careful consideration.