IRA Rollover Guide: Move Your Money Without Costly Mistakes

When Jennifer left her job last March, her HR department handed her a packet of paperwork and wished her well. Somewhere in that stack was a form about her 401(k). She meant to deal with it but got busy with her new position. She kept meaning to handle it. Then the check arrived.

Her former employer had automatically distributed her 401(k) balance — $85,000. But the check wasn't for $85,000. It was for $68,000. The company had withheld 20% for taxes, as required by law for indirect distributions.

Jennifer had 60 days to deposit the full $85,000 into an IRA to avoid taxes and penalties. But she only had $68,000. To complete the rollover, she'd need to come up with $17,000 from her own pocket within two months.

"I didn't have $17,000 lying around," Jennifer said. "I deposited what I had, but that missing amount became a taxable distribution. With the 10% early withdrawal penalty on top — I was only 48 — I ended up owing over $7,000 to the IRS."

This is how rollovers go wrong. Not through bad intentions, but through small delays and misunderstandings that create expensive consequences. The rules around moving retirement money seem designed to trip people up. Understanding them is worth thousands of dollars.

The critical difference: direct versus indirect

When you move retirement funds, the method matters as much as the destination. Get this wrong, and you're in Jennifer's situation.

A direct rollover — sometimes called a trustee-to-trustee transfer — moves money straight from your old account to your new one. You never touch it. The check, if there is one, gets made out to your new custodian "for benefit of" you, not to you personally. This is the safe way. No withholding. No 60-day deadline. No risk.

An indirect rollover puts the money in your hands first, then expects you to deposit it into a new account within 60 days. If your old account was a 401(k), your employer must withhold 20% for taxes — even though you're planning to roll it over. You have to replace that 20% from your own funds, then claim it back when you file your taxes. Miss the deadline, and the entire distribution becomes taxable income plus a 10% penalty if you're under 59½.

The 20% withholding is mandatory for 401(k) distributions going to individuals. It exists because the IRS assumes some people will spend the money rather than complete the rollover. By withholding 20%, they collect taxes upfront from those who don't follow through. But it creates a painful cash flow problem for everyone else.

Jennifer's mistake wasn't malice or negligence. She just didn't know that when her former employer sent that check to her personally, it triggered the withholding requirement and started the 60-day clock. By the time she understood what had happened, her options had narrowed dramatically.

How to execute a rollover correctly

The process requires coordination between your old account, your new account, and sometimes your own attention to detail. Here's how it should work.

First, open your new IRA before initiating anything. Call Vanguard, Fidelity, Schwab, or whatever brokerage you've chosen. Tell them you want to open an IRA for a rollover from a 401(k). They'll need some information and will give you an account number. Have this ready before you contact your old plan.

Second, contact your old 401(k) administrator. The phone number is on your statements. Tell them you want a direct rollover to your new IRA. They'll need the receiving institution's name, your new account number, and the address to send the check or wire the funds. Be explicit that you want a direct rollover — don't let them send the money to you personally.

Third, specify how the check should be made out. It should say something like "Fidelity Investments FBO Jennifer Smith" — not just "Jennifer Smith." The "FBO" (for benefit of) designation tells everyone this is a direct rollover, not a personal distribution.

Fourth, track the transfer. Get confirmation of when the funds will leave and follow up with your new custodian to verify receipt. Money in transit between institutions is money in limbo — make sure it arrives where it should.

Fifth, invest once the funds arrive. Rollover money often lands in a money market or cash position within your new IRA. It won't grow meaningfully until you invest it according to your allocation strategy. Don't let it sit in cash for months while you forget about it.

The whole process typically takes one to three weeks. Some plans are faster; some bureaucratic 401(k) administrators take longer. But with a direct rollover, you're protected regardless of timing. The 60-day deadline doesn't apply when you never personally receive the funds.

The once-per-year rule and why it matters

For IRA-to-IRA rollovers specifically, the IRS imposes a once-per-year limitation. You can only do one indirect rollover from any IRA to any other IRA within a 12-month period. This limit applies across all your IRAs — not per account, but per person.

Violate this rule, and the second rollover is treated as a taxable distribution. You'll owe income taxes on the full amount, plus a 10% penalty if you're under 59½, plus potentially a 6% excess contribution penalty if you deposited it into the receiving IRA.

The good news: this rule doesn't apply to direct rollovers. You can do unlimited direct (trustee-to-trustee) transfers between IRAs. It also doesn't apply to 401(k) rollovers — you can roll over from a 401(k) to an IRA regardless of whether you've done another rollover that year.

The safest approach is simple: always use direct rollovers. They're not subject to the once-per-year rule, they don't trigger withholding, and they eliminate the 60-day deadline stress. There's rarely a good reason to choose an indirect rollover when direct is available.

When rolling over isn't the right choice

Most people should roll their old 401(k) to an IRA when they leave an employer. But not everyone. Several situations favor keeping money where it is — or moving it somewhere unexpected.

The Rule of 55 provides penalty-free access to your 401(k) if you leave your employer in or after the year you turn 55. This exception doesn't apply to IRAs. If you're 56 and might need some of that money before 59½, keeping it in the 401(k) preserves your penalty-free access. Roll it to an IRA, and you lose that flexibility.

Creditor protection varies by state and account type. Federal law protects 401(k) assets from creditors with almost no exceptions. IRA protection depends on your state — some states protect IRAs fully, others only partially. If you're in a profession with liability exposure or concerned about lawsuits, the 401(k) might offer stronger protection.

Some 401(k) plans offer institutional investment options unavailable in retail IRAs. Stable value funds, for example, provide bond-like returns with less volatility but aren't available to individual investors outside employer plans. Large company 401(k)s sometimes have institutional share classes with expense ratios far below retail equivalents.

If you own highly appreciated company stock in your 401(k), rolling it over might be a mistake. The Net Unrealized Appreciation (NUA) strategy allows you to transfer company stock to a taxable brokerage account (not an IRA), pay ordinary income tax only on your cost basis, and pay long-term capital gains rates on all the appreciation when you eventually sell. For someone with $50,000 of cost basis in stock now worth $200,000, NUA could save tens of thousands in taxes compared to a rollover.

And if you're still working past 73 and participating in your current employer's 401(k), you can delay RMDs from that plan until you retire. You might even roll old 401(k)s and IRAs into your current employer's plan to consolidate and delay all RMDs while you're still working.

The pro-rata problem

If you have both pre-tax and after-tax money in your IRAs — which happens when you've made non-deductible IRA contributions over the years — rollovers get complicated.

The IRS treats all your Traditional IRAs as one pool for distribution and conversion purposes. If your total IRA balance is $90,000 pre-tax and $10,000 after-tax (from non-deductible contributions), then 90% of any distribution or conversion is taxable, regardless of which specific account you withdraw from.

This matters for backdoor Roth contributions. The strategy involves making a non-deductible Traditional IRA contribution, then converting it to Roth. In theory, you've contributed after-tax money and convert it tax-free. In practice, if you have other pre-tax IRA money, the conversion is proportionally taxable under the pro-rata rule.

The solution: roll your pre-tax IRA money into a 401(k) before doing backdoor Roth. Most 401(k) plans accept rollover contributions. Once the pre-tax money is in your 401(k), your remaining IRA balance is only after-tax money, and your backdoor Roth conversion becomes tax-free.

Moving forward with confidence

Rollovers are one of the few truly "free" moves in retirement planning — when executed correctly. No taxes, no penalties, just moving your money from one place to another.

The key is doing it right: direct rollover, not indirect. New account open before initiating. Clear communication with both institutions. Follow-up to confirm receipt. And careful consideration of whether rolling over is actually the right choice for your situation.

Jennifer eventually recovered from her rollover mistake. She paid the taxes, learned an expensive lesson, and is now meticulous about how she handles retirement money. But she still thinks about that $7,000 — what it could have become over 20 more years of compounding.

"I tell everyone now," she says. "When they change jobs and ask about their 401(k), I tell them exactly what to do and exactly what not to do. Nobody should make the mistake I made."

Need help navigating a complex rollover situation? Connect with a retirement advisor who can guide you through the process and ensure you don't leave money on the table.