401(k) rollover to an IRA: what you need to know

If you want to move money from your 401(k) account into an IRA, contact your plan administrator and request a direct rollover. They’ll send the funds directly to your IRA provider (by check or wire) or send you a check to forward to the IRA provider. Either way, the check is made out to the IRA provider, not to you personally. When the rollover is done this way, taxes are usually not withheld. Just be sure to follow your plan’s rules so the transfer is treated as a rollover, not as a taxable withdrawal.

What’s the difference between a direct rollover and an indirect rollover?

You have two primary ways to move your money from a 401(k) to an IRA: a direct rollover and an indirect rollover. A direct rollover is usually easier because the money goes directly to your IRA, helping you avoid mandatory tax withholding and potential tax issues or penalties.

What happens to your 401(k) when you leave a job or retire?

When you leave a job or retire, you have an important decision to make about the money in your retirement account, such as a 401(k) or 403(b). You generally have four options:

If you decide to roll your money to an IRA (option one), you’re moving your retirement savings from your employer’s plan into an IRA that accepts rollovers. Depending on your goals and tax situation, you can move pretax money into a traditional IRA or convert it to a Roth IRA (after-tax). If you already have an IRA, you may be able to roll the money into that existing account instead of opening a new one. Because each choice can have different tax consequences, it’s a good idea to talk with a financial or tax professional before you decide.

Also, think carefully before cashing out your account. Depending on your age and situation, taxes and penalties can take a big chunk out of your savings and leave less money growing for retirement. Keeping your money invested can help you stay on track with your long-term retirement goals.

Can you withdraw money from your rollover IRA?

You may be able to take money out of your rollover IRA, but the tax consequences depend on your age and situation. In many cases, you’ll pay income taxes on the amount you withdraw, and you may also owe a 10% early withdrawal penalty if you’re under age 59½ and no exception applies. Because the rules can be complex, it’s important to understand them before taking money from your rollover IRA or any retirement account.

Early withdrawal penalty—what it means for you

The IRS generally charges a 10% early withdrawal penalty (an extra tax) if you take money out of a retirement account before age 59½. Once you reach 59½, this penalty usually no longer applies, but withdrawals from a traditional IRA may still be taxed as ordinary income.

There are some situations where you may avoid the 10% penalty before age 59½ for IRAs and other retirement plans, including:

• Death
• Disability
• Large unreimbursed medical expenses (above 7.5% of your adjusted gross income)
• A series of substantially equal payments that generally must continue for five years or until you reach age 59½, whichever is later

If you have an IRA, there are additional penalty exceptions (with rules and limits), such as:

• Qualified higher education expenses
• Qualified first-time homebuyer expenses (up to $10,000 lifetime limit)
• Health insurance premiums while unemployed
• Qualified birth or adoption distributions
• Qualified military reservist distributions
• Personal emergency expense distributions
• Domestic abuse victim distributions
• Certain qualified disaster recovery distributions

Note: Even if you qualify for an exception to the 10% penalty, you may still owe regular income taxes on some or all of the withdrawal.

Roth IRA withdrawals—how the five-year rule works

Roth IRAs are funded with after-tax money so that qualified withdrawals can be completely tax-free. But there are special rules for investment earnings and money you’ve converted from other retirement accounts.

You can usually withdraw your regular Roth IRA contributions tax- and penalty-free at any time because you already paid taxes on that money. Investment earnings follow different rules. When you withdraw from a Roth IRA, the IRS generally treats the money as coming out in this order:

1 Your regular Roth IRA contributions

2 Taxable conversion contributions

3 Nontaxable conversion contributions

4 Earnings

To withdraw earnings tax-free, you generally need to meet the Roth IRA five-year rule. The five-year period begins on January 1 of the tax year when you first put money into any Roth IRA (either by contribution or conversion). If you have more than one Roth IRA, the five-year rule is based on the earliest one you funded.

Note: Separate five-year rules also apply to Roth IRA conversions (see below). These may affect whether converted amounts are subject to the 10% early withdrawal penalty if you take money out before you’re age 59½ or meet the five-year requirement.

Your withdrawal of earnings must usually be a qualified distribution to be tax-free. That means you’ve met the five-year rule, and one of these events applies:

• You’ve reached age 59½
• Death
• Disability
• A qualified first-time homebuyer withdrawal (subject to limits)

Money from Roth IRA conversions can be subject to extra rules. If you’re under age 59½ and take out certain taxable conversion amounts before their own five-year period is up, you may owe the 10% early withdrawal penalty. Each conversion has its own five-year clock, starting on January 1 of the year you did that conversion. After you reach age 59½, this conversion-related penalty generally no longer applies.

Know the withdrawal rules for your retirement accounts

There are several rules for withdrawing money from rollover IRAs and other retirement accounts. If you have more than one account, understanding the withdrawal rules and tax implications for each account can be more complicated than you expected. Here are some tips to help you manage your retirement savings:

• Consider consolidating your savings into one account³
• Know how each account is taxed
• Keep track of the timing rules for Roth contributions and conversions
• Understand the taxes and possible penalties that may apply to early withdrawals

Before you take money out, it’s a good idea to talk with a tax or financial professional so you understand the tax consequences and any other impacts on your retirement savings.