Will I Pay Taxes on an IRA Rollover or Transfer?

Dana Anspach

May 6, 2024

As you near retirement, it often makes sense to consolidate retirement accounts. You may have IRAs and 401(k)s at several different places or funds still in plans with past employers. When you rollover or transfer these accounts is it taxable? If you do it right, the answer is no.

Individual Retirement Accounts, called IRAs, are one of the most common and accessible ways to save for retirement. Over the years, the rules governing IRAs have changed. Many people think they know how an IRA works or what they can do with it, but every week I still surprise people with some of the IRA facts I share below.

1. What is an IRA rollover and why would you want to do one?

A rollover is simply the process of moving your retirement savings from your retirement plan at work (from a 401(k), 403(b), profit-sharing plan, etc.) into an IRA. You typically do this when you leave the company. Rollovers, when done correctly, are tax-free transfers to another retirement account.

2. What might be some of the benefits to rolling over into an IRA, as compared to leaving funds in a company-sponsored plan?

IRAs typically provide more investment choices, such as the ability to buy individual bonds, CDs, or other retirement investments which may not be available within your 401(k) or 403(b) plan. In addition, you may be able to find investments with lower fees than the funds in your company plan. Also, it is easier to keep up on address changes, beneficiary changes, direct deposit changes, and manage investments when you consolidate your retirement accounts in one place, typically in an IRA, at retirement. However, you should always examine total fees and services before making a decision to move funds.

3. What is the 60-day rule?

When you move funds from one IRA or company plan to a new IRA, funds must be deposited in the new IRA account no later than 60 days from when they were withdrawn from the old one. If you do not do this, the funds will be taxed. (There are exceptions, in which case you can apply for a waiver.)

4. Can I move funds into an IRA from a company retirement plan while I’m still working?

Some company retirement plans allow an employee to rollover funds to an IRA while still working by using an in-service distribution; however, most plans do not allow this. Call your company’s plan sponsor to find out if they allow this option.

5. What should I do with my company-sponsored plan if I leave that employer?

Depending on your own situation, it could make sense to rollover funds into an IRA. However, if you are between the ages of 55 and 59 1/2, leaving funds in the plan may allow you to access them without paying a penalty tax. Read the documents from your plan’s sponsor carefully. To avoid tax withholding, choose a direct IRA rollover with a check made payable to the new financial institution. If you do not do a direct IRA rollover, 20% of the amount will be withheld for federal taxes. Although most people think of an IRA rollover as moving funds from a 401(k) to an IRA, there is also a reverse rollover where you move IRA money back into a 401(k) plan. This could be a wise option if your employer offers good fund choices with low fees.

6. What is the difference between an IRA rollover and an IRA transfer?

An IRA transfer occurs when you move IRA funds from one financial institution directly to an IRA at another institution. As long as there is no distribution payable to you, then the transfer is tax-free. A rollover is when you move funds from a company plan, such as a 401(k) or 403(b) to an IRARollovers and transfers do not count toward maximum contribution limits.

7. What is the most common IRA Rollover/IRA Transfer mistake?

In addition to not executing rollovers within 60 days, sometimes we see mistakes in how the transactions are reported to the IRS. We counsel clients to pay close attention to documentation regarding rollovers. Occasionally, plan custodians incorrectly report the transaction on the 1099-R form. To ensure you aren’t taxed on an IRA rollover or transfer, carefully explain any IRA rollover or transfer transactions to your tax preparer.

8. What is an IRA?

An IRA is an Individual Retirement Account. When you contribute to an IRA, you are putting money aside for your future so you will have some money when you retire. Think of an IRA as a type of savings account where you can invest in many different types of things, but you will not withdraw from it until later. You can use the money you deposit into your IRA to invest in CDs, government bonds, mutual funds, stocks, and almost any other type of financial investment you can think of.

9. What is the benefit of an IRA?

Funds that you deposit inside of an IRA have tax advantages over funds that you deposit in a regular bank or investment account. In a regular bank or investment account, you receive a 1099 tax form each year and must report the interest and dividends earned on your tax return each year. In an IRA, the money grows tax-deferred, and you don’t pay taxes until you withdraw it.

10. Where does one open an IRA account?

You can open an IRA account at a bank, brokerage firm, mutual fund company, insurance company and various other financial institutions.

11. What are the different types of IRA accounts?

The two main types of IRAs are Traditional IRAs and Roth IRAs.

  • With a Traditional IRA, there are two types of contributions: deductible and non-deductible.
  • With a Roth IRA, contributions are not deducted, but they grow tax-free.

With either type of IRA, you can make a contribution on behalf of a  spouse. Sometimes this is called a spousal IRA.

There are also two types of plans that self-employed people or small business owners can set up; either a SEP IRA or a SIMPLE IRA. The rules for these plans and the contribution limits are different than for a Traditional or Roth IRA.

12. What are the specifics of a Traditional IRA?

Traditional IRAs were introduced by Congress in 1974 to encourage people to save for retirement by offering special tax treatment for these funds.

Contributions to a Traditional IRA are tax-deductible if you and your spouse do not participate in a company-sponsored retirement plan. If one or both of you do contribute to a company-sponsored plan, then you will need to check the income limitations to see if you can deduct your IRA contribution. If you are not eligible to make a tax-deductible IRA contribution, you may still make a non-deductible IRA contribution.

Funds inside of an IRA grow tax-deferred. Tax-deferred means you do not pay income taxes on interest, dividends and capital gains until you take a withdrawal. Tax deferral is a tremendous benefit.

Since IRAs are designed for retirement, to discourage early withdrawals, there is typically a 10% penalty tax if you withdraw money from an IRA before age 59½. So, you are supposed to leave the funds in there until retirement age.

But you can’t leave money in a Traditional IRA forever. Once you reach a certain age – 73, if you were born between 1951 and 1959; 75, if you were born on or after 1960 – you must start making required minimum distributions (abbreviated as RMDs.) Interestingly enough, RMDs are not required on Roth IRAs.

13. Is there a maximum amount you can contribute to an IRA each year?

The maximum amount you can contribute to a Traditional IRA and/or Roth IRA in 2023 is $6,500 if you’re under age 50, and $7,500 if you’re 50 or older. (Up from $6,000 and $7,000 limits in 2022.)

You cannot contribute the full amount to both a Traditional and a Roth IRA, but you can split the amount between the two. You have until April 18, 2023 and April 15, 2024, respectively, to contribute for the year prior.

There are income limits, based on your modified adjusted gross income (MAGI), to being allowed to contribute to a Roth IRA. For example, in 2023, if a married couple earns more than $218,000, their ability to contribute to a Roth IRA begins to be phased out. This phase-out begins at $138,000 of MAGI for a single tax filer.

However, you have access to a Roth 401(k) through your employer, you can contribute to that and no income limitations apply.

There is also a difference between a contribution to an IRA and a conversion. A conversion is where you move money from a Traditional IRA to a Roth IRA. Conversions do not count toward your contribution limit.

14. What are the specifics of a Roth IRA?

The basic difference between a Roth IRA and a Traditional IRA is that funds inside of a Roth IRA grow tax-free. This means you will never pay income taxes on interest, dividends and capital gains on funds that accumulate inside of a Roth IRA as long as you follow the Roth IRA withdrawal rules. For example, one of the rules is that you must be at least 59½ to withdraw any interest or gains without being taxed.

15. Why doesn’t everyone contribute to an IRA?

You must have earned income to contribute to any type of IRA. The only exception is if you are married, in which case the spouse with earned income can make an IRA contribution for themselves and to a spousal IRA on behalf of the non-working spouse.

16. What if I have a financial emergency and have to access funds in an IRA?

You are allowed, within any 12-month period, to withdraw funds, but you must redeposit these funds within 60 days to avoid being taxed and penalized (if you are under age 59½). There are also a few exceptions to the early-withdrawal penalty tax, such as specific situations where you need funds to cover excess medical expenses or health insurance costs during a time when you are unemployed.

And, keep in mind, while many 401(k) plans allow you to borrow against your account balance, you cannot take a loan from an IRA.

17. What happens if I inherit an IRA?

IRAs inherited from spouses can be moved into your own IRA, or you can keep it as an inherited IRA, but IRA funds inherited from non-spouses must be withdrawn within 10 years and will be taxed according to the type of IRA – taxable distributions if it was a traditional IRA, tax-free distributions if it was a Roth IRA.