What Is an Indirect Rollover IRA & How Does It Work?

An indirect IRA rollover allows individuals to move funds from one retirement account to another, serving as a method to consolidate retirement savings or change investment custodians. This process involves the funds being distributed directly to the account holder, who then becomes responsible for redepositing the money into a new, eligible retirement account. It differs from a direct rollover, where funds are transferred directly between financial institutions without the account holder ever taking possession of the money. While both methods preserve the tax-deferred status of retirement savings, the indirect rollover introduces specific requirements and considerations due to the individual’s temporary control of the funds.

Understanding the Indirect Rollover Process

The indirect rollover process begins when funds are withdrawn from an existing retirement account, such as a 401(k) or IRA, and paid directly to the individual. This distribution can be received via check or direct deposit into a personal bank account. Once the individual receives these funds, a critical timeframe begins for the rollover to remain tax-free.

The individual must redeposit the entire distributed amount into an eligible retirement account within 60 days of receiving the funds. This is known as the 60-day rule, a fundamental component of Internal Revenue Code Section 408(d)(3) for IRAs. Failing to complete the rollover within this 60-day period results in the distribution being treated as a taxable withdrawal. If the deadline is missed, the distribution becomes fully taxable as ordinary income.

Furthermore, if the account holder is under age 59½, the distribution may also be subject to a 10% early withdrawal penalty, as outlined in Internal Revenue Code Section 72(t). The IRS may, in limited circumstances, waive the 60-day requirement if the failure to meet the deadline was due to events beyond the individual’s reasonable control, such as casualty or disaster.

Essential Rules and Limitations

Beyond the 60-day rule, specific IRS regulations govern indirect IRA rollovers to ensure their proper use. A significant limitation is the “one-rollover-per-year” rule, which applies to IRA-to-IRA indirect rollovers. This rule, clarified in IRS Publication 590-A, means an individual can only complete one indirect rollover from any of their IRAs (including traditional, Roth, SEP, and SIMPLE IRAs) to another IRA within any 12-month period.

This limitation does not apply to rollovers from employer-sponsored plans, such as 401(k)s, 403(b)s, or 457(b)s, into an IRA. It also does not apply to direct rollovers (trustee-to-trustee transfers) between IRAs or to conversions from a traditional IRA to a Roth IRA. Funds from various retirement accounts can generally be rolled over indirectly into a traditional IRA, including those from 401(k)s, 403(b)s, 457(b)s, SEP IRAs, and SIMPLE IRAs, provided certain conditions are met for SIMPLE IRAs.

Not all distributions are eligible for rollover. Required Minimum Distributions (RMDs) cannot be rolled over, as they are mandatory withdrawals that must be taken from a retirement account once the account holder reaches a certain age. Additionally, non-deductible IRA contributions generally cannot be rolled over to a Roth IRA indirectly without triggering specific tax considerations related to the pro-rata rule if other pre-tax IRA funds exist.

Tax Implications and Reporting

A notable tax implication of an indirect rollover from an employer-sponsored plan is the mandatory 20% federal income tax withholding. This withholding, required by Internal Revenue Code Section 3405(c), occurs when funds are distributed directly to the individual from a plan like a 401(k). Even though 20% is withheld, the individual must still roll over 100% of the original gross distribution within the 60-day window to avoid taxes and penalties. This often means the individual needs to use other personal funds to cover the 20% that was withheld and sent to the IRS.

The withheld amount is then reconciled when the individual files their federal income tax return, typically resulting in a tax credit or refund if the rollover was successfully completed. The rollover transaction must be reported to the IRS. The distributing institution issues Form 1099-R, “Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.,” detailing the gross distribution and any federal income tax withheld.

The receiving IRA custodian reports the rollover contribution on Form 5498, “IRA Contribution Information,” which is typically sent to the account holder in May of the following year.