When you leave a job, one of the biggest financial choices is what to do with your 401(k) or other retirement plan. Cashing out may seem appealing, but it can cost you in taxes, early withdrawal penalties, and lost long-term growth.
Rolling the money into an IRA is a smarter way to protect your savings. A rollover IRA keeps the tax-deferred benefits, avoids penalties, and often gives you more flexibility with investments than an employer plan.
Handled correctly, the process is straightforward and ensures your retirement money keeps working for you instead of shrinking from fees or tax hits.
Key Takeaways
- A rollover IRA lets you move money from an employer-sponsored retirement plan, such as a 401(k), into an IRA while keeping its tax-deferred status and avoiding early withdrawal penalties.
- Advantages include no setup fees, low transaction costs, unlimited rollover amounts, more investment choices, and the option to move funds into a future employer’s plan.
- You can complete a rollover through a direct transfer (the safest way to avoid taxes and penalties) or an indirect rollover (which is more complicated and may involve tax withholding).
What Is a Rollover IRA, and Why Should You Consider One?
A rollover IRA is an individual retirement account created to hold money transferred from an employer-sponsored plan such as a 401(k), 403(b), profit-sharing, or Keogh plan. The main purpose is to keep your savings growing on a tax-deferred basis while avoiding early withdrawal penalties.
For many people, rolling money into an IRA offers greater flexibility than leaving it in an old employer’s plan. It can also prevent the costly mistake of cashing out retirement savings too early.
401(k) vs. Rollover IRA vs. Cashing Out
When you leave a job, you generally have three options for your retirement savings:
- Leave it in your 401(k): Some plans allow you to leave funds where they are, but you’ll be stuck with the original plan’s limited investment menu and possibly higher fees.
- Roll it into an IRA: This choice keeps your tax advantages intact, gives you access to a wider range of investments, and often comes with lower costs. You can also move it into a future employer’s plan later if you want.
- Cash it out: While this provides immediate access to money, it usually means paying income taxes plus a 10% penalty if you’re under 59 ½. You also lose out on years of compound growth.
For most savers, a rollover IRA strikes the best balance of preserving tax benefits, reducing fees, and expanding investment options.
Benefits of a Rollover IRA
Rolling your savings into an IRA can help you sidestep both taxes and penalties—as long as you transfer the funds correctly. Beyond those advantages, rollover IRAs offer several additional benefits:
- No setup fees: Opening the account and moving money in is generally free.
- Low ongoing costs: Some providers charge small brokerage or fund fees, while others waive them entirely.
- Unlimited rollover amounts: You can transfer your full balance without penalty, no matter how large it is.
- More investment choices: Unlike most 401(k) plans, IRAs allow you to invest in stocks, bonds, ETFs, and other assets.
- Portability: If your next employer offers a qualifying plan, you can transfer funds from your IRA into it, or simply keep them in your IRA.
Step-by-Step: How to Roll Over a 401(k) to an IRA
You have two ways to move money from a 401(k) or other employer plan into an IRA. A direct rollover sends the money plan-to-custodian and keeps taxes out of the way. An indirect rollover sends the money to you first and adds deadlines, withholding, and extra steps. Here’s exactly how each works.
Direct Rollover (Best for Most Savers)
- Open a traditional IRA with your chosen provider.
- Call your old plan and request a “direct rollover” or “trustee-to-trustee transfer.”
- Give the plan your IRA custodian name, mailing address, and your IRA account number.
- Ask that any check be made payable to the custodian “FBO [Your Name] IRA.” If the plan mails the check to you, forward it unopened to your IRA provider.
- Confirm the deposit posts as a rollover contribution in the IRA.
- Invest the funds per your plan. Keep the confirmation and later verify tax forms: you should receive a Form 1099-R with code G and a Form 5498 showing the rollover amount.
Pro tips:
- Fees: Ask the plan about any distribution or overnight-mail fees.
- Holdings: If the plan distributes shares “in kind,” confirm your IRA can accept them; otherwise, request cash.
Indirect Rollover (Use Only If You Must)
- Request a distribution payable to you. The plan will usually withhold 20% for federal taxes.
- Deposit the full gross amount into your IRA within 60 days. You must replace the withheld 20% out of pocket to avoid taxes and possible penalties.
- Tell your IRA provider the deposit is a rollover contribution.
- When you file taxes, the withheld amount may be refunded if you completed the rollover correctly.
Key risks:
- 60-Day Deadline: Miss it and the distribution is taxable; if you are under 59½, an extra 10% penalty may apply.
- Withholding Cash Gap: If you cannot replace the 20%, that portion becomes taxable.
- One-Per-Year Rule: This rule applies to IRA-to-IRA 60-day rollovers, not plan-to-IRA direct rollovers. Direct rollovers have no annual limit.
- Roth Money: Pre-tax 401(k) funds belong in a traditional IRA. Roth 401(k) money belongs in a Roth IRA. Mixing them creates taxes.
Rules and Tax Considerations for Rollover IRAs
Rolling over retirement savings can save you thousands in taxes and penalties, but only if you follow IRS rules closely. Here are the key points to keep in mind.
One-Rollover-Per-Year Rule
You can only do one 60-day rollover between IRAs in a 12-month period. This rule does not apply to direct rollovers from a 401(k) or other employer plan to an IRA, which are unlimited.
60-Day Deadline
If you receive the funds personally in an indirect rollover, you must deposit the full amount into your IRA within 60 days. Miss the deadline, and the distribution is taxable. If you’re under 59½, you’ll also face a 10% early withdrawal penalty.
Mandatory Tax Withholding
Employer plans usually withhold 20% of an indirect rollover for federal income tax. To complete the rollover without penalty, you must replace the withheld amount out of pocket.
Roth vs. Traditional Accounts
Pre-tax 401(k) funds should go into a traditional IRA to maintain tax deferral. Roth 401(k) funds must go into a Roth IRA. You can also choose to convert traditional funds into a Roth IRA, but you’ll owe income tax on the converted amount that year.
See also: What’s the Difference Between a Traditional IRA & a Roth IRA?
Required Minimum Distributions (RMDs)
Once you reach RMD age, you cannot roll those required withdrawals into an IRA. They must be taken as taxable income.
Reporting to the IRS
Your old plan will issue a Form 1099-R showing the distribution. Your IRA custodian will file Form 5498 confirming the rollover. Keep both for your records.
Bottom Line
A rollover IRA is one of the most effective ways to preserve your retirement savings when leaving a job. It protects the tax-deferred status of your money, helps you avoid early withdrawal penalties, and often provides lower fees and more investment choices than an old 401(k).
The key is handling the rollover correctly. A direct transfer is almost always the best option, since it avoids tax withholding and keeps the process simple. If you’re considering an indirect rollover or a Roth conversion, make sure you understand the rules and deadlines to prevent unexpected costs.
Done properly, a rollover IRA keeps your savings on track, gives you more control, and positions your nest egg to grow steadily until retirement.
Frequently Asked Questions
How long does it take to complete a rollover IRA?
A direct rollover usually takes one to three weeks from start to finish. Indirect rollovers may take longer since you need to deposit the funds yourself within 60 days.
Can I contribute new money to a rollover IRA?
Yes. A rollover IRA functions just like a traditional IRA once it is set up, so you can make annual contributions up to the IRS limit if you qualify.
What happens if I have both pre-tax and after-tax money in my 401(k)?
If your account contains both, the pre-tax portion can go into a traditional IRA and the after-tax portion into a Roth IRA. Keeping them separate avoids tax issues later.
Do rollover IRAs affect my future contribution limits?
No. Rolling money into an IRA does not count toward your yearly contribution limit. You can still make new contributions up to the annual maximum allowed by the IRS.
Is a rollover IRA protected from creditors?
Rollover IRAs generally receive the same federal bankruptcy protection as funds in a 401(k). However, state laws may vary on creditor protection, so it’s worth checking the rules where you live.
