What Is a Direct Rollover?

Direct Rollovers Explained in Less Than 4 Minutes

Older couple with paperwork discussing retirement strategy
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A direct rollover is a transfer of all or a portion of your retirement plan funds directly from one qualified retirement plan to another. In this type of rollover, a plan administrator or financial institution handles the entire transaction, and the account owner never actually touches the funds.

Direct rollover of a retirement plan distribution is not a taxable event. As a result, it allows you to move your money without incurring any tax penalties, and your money keeps growing tax-deferred until you withdraw it. 

To help you better understand direct rollovers, we’ll delve further into what they are, how they work, and outline some alternatives for handling your retirement account. 

Definition and Examples of Direct Rollovers

A rollover generally occurs any time you move all or part of your funds or assets from one type of retirement account to another qualified retirement savings plan, such as a 401(k) to an IRA, within 60 days. Common examples of when rollover transactions occur are when you get a new job, leave a job to start your own business, or retire. 

In these situations, you can generally choose to roll your assets into the new employer’s retirement plan, roll it into an IRA, or take a cash payment. The IRS also allows for an indirect rollover (also known as a 60-day rollover), which means the account holder receives a payment, then re-deposits it to another 401(k), IRA, or similar plan within 60 days.  

A direct rollover means that the assets are paid directly to the new plan administrator and not the individual. This type of rollover ensures that the entire account balance remains in your retirement savings and the assets continue to grow tax-free. 

If you don’t roll over your payment, it will be counted as taxable income, and you may be subject to a 10% early withdrawal penalty if you’re under age 59 ½.

How Does a Direct Rollover Work?

The IRS sets the rules around tax-deferred retirement plans, including which accounts are eligible for rollovers, their tax rates, and associated penalties. Most types of retirement savings vehicles are eligible for rollover transactions, but with different rules and limitations. 

Imagine you have a 401(k) with $10,000 in the account and you’re getting a new job. Rolling over the full balance of your old account directly to another plan or IRA means two things: 

  • No taxes will be withheld from your transfer amount
  • You avoid the 10% additional tax on early distributions

To initiate a direct rollover, just ask your financial institution to transfer the payment to the new plan or IRA, and follow their instructions. 

Alternatives to Direct Rollovers

As mentioned, you have options when it comes to what happens to your old retirement accounts. Let’s say you have an employer-sponsored retirement account worth $10,000 dollars. 

  • Indirect rollover: If you do an indirect rollover or 60-day rollover, the plan administrator withholds 20% as required for taxes and sends you a check for $8,000. You can still roll over the entire amount within 60 days tax-free, but you’ll need to make up the $2,000 from somewhere else.
  • Roth conversion: If your funds are in a traditional IRA, you can transfer them to a Roth IRA, known as a Roth conversion. A Roth conversion is a taxable event, which means 20%, or $2,000, withholding is mandatory on the $10,000 transfer.
  • Direct rollover: If you decide to do a direct rollover from plan to plan, or a trustee-to-trustee transfer (moving assets from one IRA directly to another IRA), no taxes will be taken from the transfer amount. The full $10,000 will be transferred to your new account.

In the event that the plan account is $1,000 or less, the plan administrator will often pay it to you directly, minus 20% income tax withholding.

Each option has its benefits, but direct rollovers can be the most straightforward way to avoid tax penalties and hold on to as much of your money as possible. 

Key Takeaways

  • A direct rollover is a simple way to move financial assets from one retirement account, such as a 401(k) or IRA, directly to another IRA or retirement plan.
  • In a direct rollover, the bank or plan administrator will transfer the funds directly to the new account on your behalf.
  • A direct rollover won’t trigger any tax withholding, allowing your assets to keep growing tax-deferred until you withdraw them later. 
  • If you want to do an indirect rollover or Roth conversion, it can have tax consequences.