Direct vs. Indirect Rollover: How the 60-Day Rule Works
There are two ways to move money out of an old 401(k), and one of them can trigger taxes and penalties you didn't plan for. The difference comes down to who the check is made out to.
Direct rollover
Your old plan sends the money straight to your new IRA or employer plan, either electronically or by a check made out to the new account. Nothing is withheld for taxes and nothing is taxable. For most people this is the right choice.
Indirect rollover
Your old plan pays the money to you. When that happens, the plan is required to withhold 20% for federal income tax. You then have 60 days to deposit the money into an IRA or another plan.
The 20% trap, with numbers
| Step | Amount |
|---|---|
| Old 401(k) balance | $50,000 |
| Withheld for taxes (20%) | $10,000 |
| Check you receive | $40,000 |
| Amount you must deposit within 60 days to avoid tax | $50,000 |
To roll over the full balance, you have to add the missing $10,000 from your own savings. You get the withheld amount back as a refund or credit when you file your tax return. If you deposit only the $40,000, the $10,000 shortfall is treated as a distribution. It's taxed as income, and if you're under 59½, you'll usually owe a 10% penalty on it too.
Missing the 60-day deadline
Anything not deposited within 60 days is generally treated as a taxable distribution. The IRS can waive the deadline in limited situations, such as a financial institution's error or a serious illness, but you shouldn't count on it.
The once-a-year rule
You can do only one indirect rollover from one IRA to another IRA in any 12-month period. That limit doesn't apply to direct trustee-to-trustee transfers or to rollovers from a 401(k) into an IRA, which is one more reason to keep rollovers direct.
This guide is general information, not tax advice. Check the IRS rules or a tax professional for your situation.