The Rollover Rules That Can Cost You Thousands: Direct vs Indirect Transfers Explained

What Is a Rollover and Why Does It Matter?

When you leave a job, one of the most important financial decisions you’ll face is what to do with your retirement savings. A rollover allows you to move funds from your old employer’s 401(k) or other qualified plan into an IRA or a new employer’s plan—without triggering taxes or penalties.

But here’s what most people don’t realize: how you execute that rollover can mean the difference between a seamless transfer and a 20% tax withholding that takes months to recover.

Direct vs. Indirect Rollovers: The $10,000 Mistake

There are two ways to roll over retirement funds, and choosing the wrong one can cost you thousands:

Direct Rollover (Trustee-to-Trustee Transfer)

Your old plan administrator sends the money directly to your new IRA or 401(k) custodian. The check is made payable to the new institution “for benefit of” (FBO) you. No taxes are withheld, and you never touch the money.

This is almost always the right choice.

Indirect Rollover (60-Day Rollover)

The plan administrator sends a check directly to you. Here’s where it gets expensive:

• Your employer must withhold 20% for federal taxes
• You have exactly 60 days to deposit the full original amount (including that 20%) into a new retirement account
• If you can’t come up with the withheld amount from other funds, that portion becomes a taxable distribution
• If you’re under 59½, you’ll also owe a 10% early withdrawal penalty on any amount not rolled over

The One-Per-Year Rule That Trips Up Smart People

Here’s a rule that catches many investors off guard: you’re only allowed one indirect IRA-to-IRA rollover per 12-month period. This applies across all your IRAs—not per account.

However, this rule does not apply to:

• Direct (trustee-to-trustee) transfers
• Rollovers from employer plans (401k, 403b) to IRAs
• Roth conversions

Violate this rule and the IRS treats the second rollover as a taxable distribution plus potential penalties.

When to Keep Money in Your Old 401(k)

Sometimes the best rollover is no rollover at all. Consider keeping funds in your former employer’s plan if:

• You have access to institutional funds with expense ratios far below retail alternatives
• You’re between 55 and 59½ and might need the money—401(k)s allow penalty-free withdrawals after age 55 if you’ve separated from service, while IRAs make you wait until 59½
• You need creditor protection—401(k) assets have stronger federal protection than IRAs in some states
• Your plan offers stable value funds that aren’t available in IRAs

The Roth Conversion Question

A job change is also an opportunity to consider a Roth conversion. When you roll traditional 401(k) funds into a Roth IRA, you’ll owe income tax on the converted amount—but all future growth becomes tax-free.

This strategy makes sense when:

• You’re in a lower tax bracket this year (perhaps unemployed between jobs)
• You expect higher tax rates in retirement
• You have cash outside retirement accounts to pay the conversion tax
• You won’t need the money for at least 5 years

Bottom Line: Process Matters as Much as Strategy

The mechanics of a retirement rollover might seem like paperwork details, but getting them wrong can cost you real money. Always request a direct rollover, keep documentation of every transfer, and when in doubt, consult with a fee-only financial advisor before moving significant retirement assets.

Your future self will thank you for the extra attention to detail.