Are Rollovers Actually Taxable? Avoid this Mistake + FAQs

Most rollovers are not taxable events if you follow IRS rules.

Moving money from one qualified retirement or savings account to another (a rollover) usually lets you avoid immediate taxes. However, certain types of rollovers are taxable (for example, converting a traditional IRA to a Roth IRA triggers taxes).

The key is knowing which rollovers are tax-free and handling them correctly to steer clear of surprise tax bills.

In this comprehensive guide, you’ll learn:

• Which rollovers are truly tax-free (and which will cost you) – covering IRAs, 401(k)s, Roth conversions, HSAs, pensions, annuities, and more under U.S. federal law.

• The critical differences between direct and indirect rollovers – and how the 60-day rule and one-rollover-per-year rule can make or break your tax outcome.

• How different accounts handle rollovers – including retirement plans (401(k), 403(b)), IRAs vs. Roth IRAs, Health Savings Accounts (HSA), Coverdell ESAs, and insurance/annuity rollovers (1035 exchanges).

• State-specific tax traps and nuances – a state-by-state breakdown of how rollovers are treated, highlighting states with unique rules (like California and New Jersey taxing HSAs, or Illinois and others that exempt retirement income).

• Proven tips to avoid common rollover mistakes – such as missed deadlines, triggering withholding, or unintended taxes – plus key terms, detailed examples, comparisons, and recent legal insights (like the Bobrow case on IRA rollovers).

Dive in to master rollover tax rules and keep your hard-earned savings tax-sheltered!

Rollover Tax Basics: When Is a Rollover Taxable vs. Tax-Free?

Rollovers allow you to transfer funds from one retirement or savings account to another without taking an income hit in that moment. In general, if you move money between similar tax-advantaged accounts and follow IRS guidelines, you won’t owe taxes on the rollover.

The transferred funds continue to grow tax-deferred (or tax-free in a Roth) in the new account. This is why rollovers are popular – they let you consolidate or switch accounts without resetting the tax clock.

However, not all rollovers are created equal. Some scenarios do trigger taxes, and mistakes in executing a rollover can likewise result in a taxable event. Here are the basics:

• Direct vs. Indirect Rollover: If you transfer funds directly from one account trustee to another (often called a direct rollover or trustee-to-trustee transfer), you avoid taxes. If the money is paid to you first and then you redeposit it (an indirect rollover), you have a short window (usually 60 days) to complete the rollover or else the IRS treats it as a taxable distribution. We’ll explain this more below.

• Same Tax “Bucket” Transfers: Moving pre-tax retirement money to another pre-tax account (e.g. a 401(k) to a traditional IRA), or Roth to Roth, is generally tax-free. You’re not changing the tax treatment, just the account location.

• Changing Tax Status: If you roll over pre-tax funds into a post-tax account (like a traditional IRA to a Roth IRA conversion), that is taxable. You’re essentially pre-paying the taxes to convert those funds into tax-free Roth money. This type of rollover – commonly called a Roth conversion – incurs income tax on the amount moved.

• One Tax-Free Rollover at a Time: The IRS allows unlimited direct rollovers, but indirect rollovers have strict limits (like the one-per-year rule for IRAs). If you violate these, the extra rollovers become taxable. More on that soon.

• No Tax on Eligible Rollovers: As long as a distribution qualifies as an eligible rollover and you complete it properly, the IRS does not count it as taxable income. “Eligible” usually means the money comes from a qualified retirement plan or IRA and isn’t one of the few things you can’t roll over (such as required minimum distributions or certain periodic payments).

In short, most rollovers are tax-neutral – you move money and owe nothing to Uncle Sam at the time. But if you do a rollover incorrectly or choose a type that’s meant to be taxable (like a Roth conversion), you could face income taxes (and possibly penalties). Next, we break down the different rollover methods and rules to keep it tax-free.

Direct vs. Indirect Rollovers (and Why It Matters)

When possible, choose a direct rollover. In a direct rollover, the funds go straight from your old account to the new account (often the check is made payable to the new trustee, not to you personally).

Because you never take possession of the money, the IRS doesn’t consider you to have received a distribution. Result: no taxes withheld, no income to report.

For example, if you leave a job and roll your 401(k) directly into an IRA, the 401(k) plan can send the money electronically or via a check made out to your IRA custodian – you never see a taxable dime.

In contrast, an indirect rollover means the money comes out to you first. Perhaps your 401(k) plan mails you a check (often minus withholding – see below) or your IRA provider gives you the funds, and then you have to deposit those funds into another eligible account yourself.

Indirect rollovers introduce risk and hassle: the clock starts ticking on the 60-day rule as soon as you receive the money. If you fail to redeposit the full amount into a qualified account within 60 days, that distribution becomes taxable income (and if you’re under 59½, likely a 10% early withdrawal penalty too). It’s easy to slip up or miss the deadline, which is why direct rollovers are the gold standard.

Another catch: If you take a distribution from an employer plan (like a 401(k)) to do an indirect rollover, federal law requires the plan to withhold 20% for taxes. For example, you ask for a $100,000 401(k) distribution intending to roll it to an IRA yourself – the plan might send you $80,000 (after withholding $20k). You then must come up with that missing $20k from other funds and roll over the full $100k into your IRA within 60 days to avoid taxes.

The $20k withheld will be applied to your taxes (or refunded) when you file your return, but in the meantime you had to make the rollover whole. If you only roll over the $80k you received, the $20k that was withheld becomes a taxable distribution. Bottom line: indirect rollovers are doable but fraught with pitfalls.

Here’s a quick comparison of Direct vs. Indirect rollover approaches for, say, a 401(k) to IRA move:

As shown, a direct rollover lets you sidestep the traps of withholding and tight deadlines. An indirect rollover gives you use of the funds briefly, but it’s easy to mess up. Always try for a direct transfer unless there’s a compelling reason not to.

Tip: If you accidentally miss the 60-day window due to circumstances beyond your control (hospitalization, error by a financial institution, etc.), the IRS may offer relief. In some cases, you can self-certify a late rollover and avoid taxes, but you must meet specific criteria. It’s better not to go there – save yourself the headache by doing it right the first time.

The 60-Day Rule and the One-Per-Year Rule

The 60-day rollover rule is crucial: for any indirect rollover, you have a 60-day window to get that money into another qualified account. Day 1 is the day after you receive the distribution. The IRS is strict – on day 61, if the money isn’t safely rolled into an IRA or other plan, it becomes taxable.

There’s no extension unless you qualify for a waiver (hardship, error, etc.). Mark your calendar and don’t procrastinate with rollover checks!

Equally important for IRAs is the one-rollover-per-year rule: You can only do one IRA-to-IRA indirect rollover in any 12-month period (not calendar year, but a rolling 365-day period) across all your IRAs. This rule catches many people off guard. For instance, if you take money from your Traditional IRA #1 and roll it to Traditional IRA #2 in January, you cannot do another 60-day rollover from any of your IRAs until the next January.

A second attempt will be disallowed – the distribution would be taxable and, if you put those funds into another IRA, it would be treated as an excess contribution (subject to a 6% penalty until removed).

This one-per-year rule does not apply to direct transfers or to rollovers between workplace plans and IRAs. It only applies when you take possession of IRA funds and redeposit them. The IRS established this rule to prevent people from serially moving money around and essentially getting interest-free 60-day “loans” from their IRAs. In a famous 2014 tax court case (Bobrow v. Commissioner), a taxpayer tried to argue that he could do multiple rollovers in a year (one from each IRA).

The court ruled against him, and the IRS now enforces the limit: one indirect IRA rollover per year, period. So plan carefully – if you’ve already done one, any further IRA moving should be done via direct trustee-to-trustee transfer (which luckily has no such limit).

Key takeaway: Use direct transfers whenever possible. If you must do an indirect rollover from an IRA, ensure you haven’t done another in the past 12 months, and complete the rollover within 60 days without fail. That keeps the transaction tax-free.

Now, let’s explore specific types of rollovers – from retirement accounts to HSAs and more – and detail their tax implications.

Retirement Account Rollovers: 401(k), 403(b), 457 & IRAs

Retirement accounts are where the term “rollover” is most commonly used. Millions of Americans roll over 401(k) or IRA funds every year. Here’s what to expect tax-wise for each:

401(k) and 403(b) Rollovers: Keeping Your Retirement Tax-Deferred

If you have money in an employer-sponsored plan like a 401(k) (for private companies) or a 403(b) (for public schools, nonprofits, etc.), you can typically roll those funds into another qualified plan or an IRA when you leave the job (or sometimes even while still employed, through an in-service rollover).

Tax treatment: A rollover from a 401(k)/403(b) into a traditional IRA is not taxable as long as you execute it properly (preferably direct trustee transfer). The money remains in the pre-tax retirement system. Similarly, you could roll over your 401(k) into a new employer’s 401(k) plan if the new plan accepts roll-ins – also tax-free. The IRS considers this a continuation of tax deferral.

One thing to watch: employer plans often include different types of money – pre-tax contributions, maybe after-tax contributions, and perhaps Roth 401(k) amounts if you had a Roth option. Each portion needs to go to the appropriate type of account in a rollover. Generally, pre-tax 401(k) dollars go to a traditional IRA (or other pre-tax plan), and any Roth 401(k) balance should go into a Roth IRA (to maintain its tax-free character). If you have after-tax contributions in your 401(k) (not Roth, just extra after-tax money), you have a special opportunity: you can direct those after-tax contributions to a Roth IRA during a rollover tax-free (since you already paid tax on those contributions), while the earnings on them go to a traditional IRA. This is sometimes called a “mega backdoor Roth” strategy. The key point: follow the rules and allocate funds to the right destination accounts to avoid taxation.

Rollover to Roth IRA: What if you want to roll over a 401(k) directly into a Roth IRA? This is allowed – effectively it’s like converting your 401(k) to Roth. Because a normal 401(k) is pre-tax money, moving it into a Roth IRA means you’ll owe taxes on the entire amount rolled over (minus any after-tax contributions that might be in the plan). The plan will usually allow a direct rollover to Roth IRA (often termed a Roth conversion rollover). The amount will be reported as taxable income to you for that year. This can be a smart move if you want future tax-free growth and can handle the tax bill now (perhaps you’re in a low tax bracket this year). Just be prepared: a big rollover from a 401(k) to a Roth IRA can spike your income for the year. No 10% penalty applies on a direct rollover to Roth (even if you’re under 59½), because it’s still a rollover, not a cash-out – but the income taxes will be due.

403(b) plans follow the same rollover rules as 401(k)s. You can roll a 403(b) to an IRA or another employer plan when eligible, without tax, or roll to a Roth IRA with taxation (just like above).

457(b) plans: If you have a governmental 457(b) deferred compensation plan, you can also roll that to an IRA or other plan tax-free. Note that governmental 457(b) plans are eligible for rollover, but non-governmental 457 plans (offered by some nonprofits) generally cannot be rolled into an IRA – those usually must stay in the plan or be paid out, due to different rules. For a governmental 457, once in an IRA, the funds become subject to the usual IRA rules (including the 59½ age for penalty-free withdrawals – whereas within a 457 plan you could withdraw at any age after leaving job without the 10% penalty). So consider that before rolling over a 457 – it might be advantageous to keep a 457 separate if you plan to access it before age 59½, since 457 plans don’t impose the early withdrawal penalty even if taken as cash (only regular income tax).

Pro tip: If you separate from your job at age 55 or older (50 for certain public safety employees), distributions from that employer’s 401(k)/403(b) can be taken without the 10% early penalty. This is the age 55 rule. If you think you might need your funds early, you may not want to roll that money into an IRA right away, because IRAs don’t have the age-55 exception (you generally must wait until 59½ unless you qualify for other narrow exceptions). Keeping it in the plan could preserve penalty-free access. This isn’t about rollover taxation directly, but it’s a related consideration on whether to roll over or not. Always weigh the pros and cons of rolling over vs. leaving funds in a 401(k) (we cover that in a later section).

IRA-to-IRA Rollovers: Transfers vs. Conversions

Traditional IRAs are another common place for rollovers. You might roll a work plan into an IRA, or you might move IRA money between financial institutions. IRA-to-IRA rollovers can be done via the 60-day method (subject to the one-year rule we discussed) or by direct transfer (which is not even considered a reportable rollover by the IRS because it’s direct trustee-to-trustee).

• If you move a Traditional IRA to another Traditional IRA, and you do it directly or via a one-time 60-day rollover, no tax is due. It’s the same type of account, so nothing has happened from a tax perspective. You’re essentially just changing custodians or consolidating accounts. The only taxes that might arise is if you accidentally break the one-per-year rule or miss the 60-day deadline on an indirect move, in which case the amount would be treated as a distribution (taxable) instead of a rollover.

• If you move funds from a Traditional IRA to a Roth IRA, that’s a Roth conversion, which is taxable. Let’s dive into conversions next, since that’s a special type of rollover.

Roth Conversions (Traditional IRA -> Roth IRA)

A Roth conversion is one rollover that is intentionally taxable. Here you take money from a traditional IRA (or other pre-tax retirement account) and convert it to a Roth IRA. The IRS treats it as if you withdrew the money (though you don’t pocket it; it goes right into the Roth) – meaning the amount converted is added to your income for that year. You’ll owe ordinary income tax on it, but once inside the Roth IRA, all future growth can be tax-free, and no future required distributions will apply in retirement. Essentially, you pay taxes now to get tax-free benefits later.

Why do a taxable rollover on purpose? Many people convert to Roth to hedge against future higher tax rates, to leave tax-free money to heirs, or to eliminate required minimum distributions on those funds. If you expect to be in a higher bracket later (or worry tax rates will rise overall), paying tax now on a conversion could save money in the long run. It’s a trade-off.

How it works: Suppose you move $50,000 from your traditional IRA to a Roth IRA this year. If all $50k was pre-tax money (no basis), that $50k will be added to your taxable income. If you’re in the 22% federal tax bracket, roughly $11,000 of federal tax would be due (plus any state tax). If part of that IRA was from nondeductible contributions (after-tax basis), that portion is not taxed again – only the pre-tax portion and earnings are taxed at conversion, allocated proportionally (the IRS pro-rata rule). For example, if 20% of your traditional IRA balance is after-tax contributions, then 20% of the conversion is tax-free and 80% is taxed.

No penalty: Importantly, the 10% early withdrawal penalty does not apply to Roth conversions, even if you’re under 59½. The IRS specifically waives the penalty for funds converted to Roth (since you’re not really taking the money out for personal use; you’re moving it between retirement accounts). However, if you have taxes withheld from the conversion distribution instead of paying them out of pocket, that withheld amount is treated as a distribution to you. That portion would be subject to taxes and a 10% penalty if you’re under 59½, because it didn’t make it into the Roth – it went to the IRS as withholding. Tip: Always try to pay the conversion tax from outside funds rather than having it withheld from the IRA withdrawal, so the full amount converts and you avoid an unnecessary penalty on the withheld chunk.

Let’s illustrate the conversion tax impact versus a normal rollover:

As shown, a normal IRA rollover changes nothing about the tax nature (so no tax owed now, but you’ll pay later when you withdraw in retirement). A Roth conversion asks you to pay tax now in exchange for no taxes later. It’s a strategic decision.

Also note, you can convert just part of an IRA to a Roth – it’s not all-or-nothing. Many people do partial conversions over several years to avoid jumping into a high tax bracket in any one year. There’s no limit on conversion amounts or how many conversions you can do (they’re not subject to the one-per-year rule because conversions are a different beast). Each conversion is simply taxed.

In-plan Roth rollovers: Some employer plans allow an “in-plan Roth conversion.” That’s where, say, your 401(k) has a Roth account option, and you move money from your traditional 401(k) portion to the Roth portion within the same plan. The tax effect is the same as a Roth IRA conversion – the amount converted is taxable income. The benefit is you don’t have to leave the plan to do it, and once converted, that money becomes Roth 401(k) money (which can later be rolled to a Roth IRA tax-free). In-plan conversions are subject to similar rules (you may need to be vested and such, but legislation in recent years made it easier to do this for more people). Again, no 10% penalty on the conversion amount, since it stays in the retirement environment.

To summarize: Rollover within same tax type = no tax; Rollover to Roth from pre-tax = taxed. Next, we’ll look at some non-retirement accounts that also have rollover provisions, like HSAs and ESAs.

Health Savings Account (HSA) Rollovers: Tax-Free Health Fund Transfers

If you have an HSA (Health Savings Account), you might change HSA providers or move funds around. HSAs are unique because they aren’t retirement accounts, but they have special rollover rules too.

Tax treatment: An HSA rollover (moving funds from one HSA to another HSA) is tax-free, just like retirement rollovers, provided you follow the rules. The IRS allows you one HSA rollover per year (per 12-month period), and it must be completed within – you guessed it – 60 days. That sounds like the IRA rule, and indeed it’s similar, but with HSAs it’s even simpler to avoid by doing direct transfers.

Direct trustee-to-trustee HSA transfer: If you have your HSA funds sent directly from your old HSA custodian to your new HSA custodian, it’s not considered a rollover at all for the one-per-year limit. You can do unlimited direct transfers between HSAs. There’s no tax and no IRS reporting needed by you (the administrators will handle any necessary coding). This is the preferred method if you’re moving HSAs – for example, if you switch jobs and want to consolidate your old HSA into your new one, usually you can fill out a transfer form and the custodians will move the money directly. No taxes, no fuss.

60-day HSA rollover: Alternatively, you can withdraw the HSA money yourself and then redeposit it into another HSA. As long as you redeposit the same amount into another HSA within 60 days, it’s not taxed or penalized. But you can only do this once per 12 months. If you try a second HSA rollover via withdrawal in the same year, the second withdrawal would be considered a regular (and taxable) HSA distribution, not a rollover.

One key difference from retirement accounts: If you fail to complete an HSA rollover properly (you miss the 60-day window or do an extra one too soon), the distribution becomes taxable and if you’re under age 65, it’s subject to a 20% penalty (because non-medical use of HSA funds before age 65 carries a 20% penalty). Essentially, a botched HSA rollover is treated like you took the money out for non-medical purposes. Ouch.

So don’t mess up that 60-day rule! But again, you can avoid the risk entirely by doing a direct transfer.

Here’s a quick comparison of HSA rollover vs. transfer:

As you can see, a direct trustee transfer is the safer route for HSAs, just like with IRAs. Use the 60-day rollover only if a direct transfer isn’t possible for some reason.

Important state note: At the federal level, HSAs have great tax benefits (deductible contributions, tax-free growth, tax-free withdrawals for medical expenses, and tax-free rollovers). However, a couple of states do not follow federal HSA rules. Notably, California and New Jersey treat HSAs like a normal taxable brokerage account. That means they tax HSA contributions (no deduction) and tax any interest or investment earnings in the HSA each year as income. If you’re a resident of CA or NJ, an HSA rollover is still not a taxable event federally, but for state tax purposes, the HSA money was never tax-free to begin with. For example, if your HSA grew by $500, California will tax that $500 as income whether or not you roll it over. When you move HSA funds to a new account, CA/NJ don’t have a concept of a tax-free rollover – essentially the account balance remains subject to state taxes as it grows. The key takeaway: Federal law = HSA rollovers tax-free; CA & NJ = tax HSA earnings regardless. This doesn’t stop you from rolling over, just remember your state tax situation. (We’ll cover more state-by-state differences later.)

One-time IRA to HSA rollover: As a bonus, there is a special rollover from an IRA to an HSA allowed by law, called a qualified HSA funding distribution. You can do this only once in your lifetime. Essentially, you can transfer money from a Traditional IRA to your HSA (up to your HSA contribution limit for the year). You won’t pay tax on that IRA withdrawal – it’s treated like a rollover into the HSA. The benefit is it effectively lets you fund your HSA with pre-tax IRA dollars (maybe useful if you have an IRA and can’t afford an HSA contribution otherwise). The catch: you forgo the HSA deduction since you used IRA funds (you can’t double dip), and you must remain eligible for an HSA (covered by a high-deductible health plan) for at least 12 months after, or else the transferred amount becomes taxable. This is a niche move but worth mentioning for completeness. It’s not a common rollover, but it’s one more tool in the tax arsenal.

In summary, HSA-to-HSA rollovers are not taxable if done right. Keep the one-year rule in mind, or better yet stick to direct transfers. Your health savings will stay fully tax-sheltered as they move to a new home.

Education Savings Rollovers: Coverdell ESA and 529 Plan Moves

Education savings accounts also have rollover provisions. Under U.S. law, you can roll funds between certain education-oriented accounts without taxes, enabling you to adjust your college savings plans as needed.

Coverdell ESA Rollovers

A Coverdell Education Savings Account (ESA) is a tax-advantaged account for education expenses (often used for private K-12 or college). Coverdell ESAs allow rollovers under specific conditions:

• Beneficiary-to-beneficiary rollover: You can roll over funds from one child’s Coverdell ESA to another family member’s Coverdell ESA tax-free, as long as the new beneficiary is an eligible family member (e.g., a sibling, step-sibling, niece/nephew, first cousin, etc. of the original beneficiary) under age 30. This often happens if the original child doesn’t need all the funds (maybe they got a scholarship or chose not to attend college) and you want to use it for a sibling. By rolling it to the new beneficiary’s ESA, you avoid having to withdraw and possibly pay taxes/penalties.

• One rollover per 12 months: Similar to other accounts, only one rollover from a Coverdell per beneficiary is allowed in a 12-month period. So you can’t keep shuffling the money around multiple times a year; plan a single rollover if needed.

• Tax consequences: If you follow the rules (family member, under age limit, within 60 days), the rollover is not taxable. If you were to withdraw money from an ESA and not roll it to another ESA for an eligible beneficiary, it would be a taxable distribution to the extent of earnings, and earnings would also face a 10% penalty if not used for qualified education. So rollovers help preserve the tax-free status of the funds for education.

• Time limit – age 30 rule: Coverdell ESAs have a quirky rule that the account must generally be used by the time the beneficiary turns 30 (except for special needs beneficiaries). Any remaining assets by that time should be distributed (taxable/penalized on earnings) or rolled over to another younger beneficiary’s ESA to avoid tax. So if your child hits 30 and still has funds, you could roll it to a younger relative’s ESA to keep it tax-sheltered.

529 Plan Rollovers

529 college savings plans are more common these days than Coverdells, and they have their own rollover rules. While a 529 isn’t explicitly mentioned in our original question’s list, it’s worth covering because it’s a significant education rollover scenario.

• 529 to 529 rollover (same beneficiary): You can roll over a 529 account to another 529 plan for the same beneficiary once within a 12-month period without tax. Why do this? Perhaps you move to a different state and want to transfer to that state’s 529 plan, or you find a plan with better investment options or lower fees. As long as you haven’t done another rollover for that child in the last year, you can redirect the funds to the new plan without it counting as a withdrawal.

• Changing beneficiary: Instead of rolling to the same beneficiary, you can also change the beneficiary on a 529 or roll assets to another 529 for a different beneficiary. To stay tax-free, the new beneficiary must be a qualified family member of the old one (similar to Coverdell rules but actually even broader list). Family includes immediate family, first cousins, etc. For example, if Child A doesn’t use all their 529 money, you can roll it to a 529 for Child B (a sibling) tax-free. Changing the beneficiary to someone in the next generation (like to a niece/nephew or grandchild) is allowed and considered a non-taxable transfer as long as they’re family. If you change it to someone not qualifying as family (or, say, to another family member’s 529 but beyond the allowed generation limits), it could be considered a non-qualified distribution and trigger tax.

• Tax impact: A proper 529 rollover or beneficiary change is not taxable and not subject to the 10% federal penalty. The money remains designated for education. If you withdraw from a 529 and do not roll it to another plan or use for education, then the earnings portion of that withdrawal is taxed and penalized 10%. So, as with other accounts, rollover keeps it tax-sheltered.

• New 529-to-Roth IRA rollover (2024): A brand-new provision (from the SECURE Act 2.0, passed in late 2022) allows certain 529 plan funds to be rolled over to a Roth IRA for the beneficiary, starting in 2024. This is meant to help use up leftover college funds. There are several conditions: the 529 must have been open for at least 15 years, you can only roll over up to $35,000 over the beneficiary’s lifetime, and you’re limited to annual Roth IRA contribution limits (the rollover counts towards that limit each year). Also, contributions made in the last 5 years (and earnings on those) are ineligible to roll. If all conditions are met, these rollovers will be tax-free (it’s essentially treating it like a Roth contribution for the beneficiary, not counting the income). This is a niche but exciting new rollover option. It means a 529 isn’t a total waste if a kid doesn’t need it for school – some can become seed money for their retirement Roth. Each state may treat this differently for state taxes, but federally it’s allowed. (Check your state – some might count it as a non-qualified 529 distribution for state purposes.)

• ABLE account rollover: You can also roll a 529 over to an ABLE account (Achieving a Better Life Experience account for disabled individuals) for the same beneficiary or a member of their family, without tax, up to annual contribution limits. This is a specialized scenario (limited through 2025 under current law).

State tax considerations for 529 rollovers: Many states give an income tax deduction or credit for contributions to their state’s 529 plan. If you claimed a deduction on state taxes and then roll the money out to another state’s plan, some states will recapture that deduction (essentially add it back to your income or impose a claw-back tax). For example, New York allows a state tax deduction for NY 529 contributions, but if you later move those funds to another state’s 529, NY will recapture the past deductions – meaning you’ll have to pay NY tax on those previously deducted contributions. States like Arkansas, Kansas, Montana, Iowa, and others have similar rules: rollovers out can trigger tax on prior benefits. Always check your state’s policy before moving 529 money. In contrast, rolling between plans within the same state or without having taken a deduction might not have any state tax impact.

Also, some states treat inbound rollovers as new contributions eligible for a deduction (notably a few states will give you a deduction if you roll in from another 529). This varies, so consult your state’s 529 program details.

Coverdell to 529 rollover: One common question: can you roll a Coverdell ESA into a 529 plan? Generally, yes, you can. The IRS allows you to take a Coverdell distribution and contribute it to a 529 plan for the same beneficiary (or another family member beneficiary) without taxes or penalties, as long as it’s done in the same manner and timing as a rollover. Essentially, they treat it as using the Coverdell for qualified education – funding a 529 is an educational purpose. You just have to complete it within 60 days and it counts as the one rollover for that ESA. This can be useful because 529s have no age limit or contribution limit (other than very high max balances), whereas Coverdells cap contributions at $2k/year and must be used by age 30. Rolling a Coverdell into a 529 can merge those funds into a potentially more flexible account, tax-free. The flip (529 to Coverdell) is not allowed, however.

Takeaway: Education account rollovers keep education savings growing tax-free. Whether shifting between siblings or to a new plan, if you stick to qualified family members and timing rules, you won’t trigger taxes. This gives families flexibility to adjust their college savings strategy as kids’ needs evolve.

Annuities, Life Insurance, and Pension Rollovers: Special Cases

Not all rollovers involve retirement or education accounts. You might have money in an annuity or cash value life insurance policy, or receive a lump-sum pension payout. These have their own tax rollover opportunities.

Annuity and Life Insurance 1035 Exchanges (Tax-Free Insurance Rollovers)

If you have a non-qualified annuity (an investment contract with an insurance company, funded with after-tax dollars) or a cash value life insurance policy, you might want to switch to a new policy or annuity. Normally, cashing out an annuity or life policy can trigger taxes on the gains. But the tax code provides for a Section 1035 exchange, essentially a rollover for insurance products.

• What is a 1035 exchange? It’s a provision (section 1035 of the Internal Revenue Code) that allows you to exchange one insurance or annuity contract for a new one without current tax liability. The logic is similar to a rollover: you’re not really cashing out and taking the money for yourself; you’re continuing the investment in a similar vehicle, just switching providers or contracts.

• Eligible exchanges: You can exchange life insurance for life insurance, life insurance for an annuity, or annuity for annuity tax-free. (Also life or annuity to long-term care insurance is allowed by certain rules.) You cannot exchange an annuity for a life insurance policy – that’s not allowed. Also, the policy/annuity owners and insured persons must meet certain criteria (generally the contract must be on the same person or insured party).

• How to do it: It must be done as a direct exchange – you don’t cash out to your bank account. Instead, the insurance companies handle it: you apply for a new policy/annuity and fill out 1035 exchange paperwork. The old contract’s cash value is transferred directly to the new contract. The old contract is then surrendered as part of the process. Done correctly, the transaction is not taxable. The cost basis carries over to the new contract. For example, you have an annuity worth $100k that you originally put $70k into ($30k gain). You 1035 exchange into a new annuity. No tax now; the new annuity has a $70k basis. If you someday cash it out, you’d then pay tax on the gain.

• Why exchange? People do 1035 exchanges to get better benefits – maybe a newer annuity with lower fees or better features, or to move cash value life insurance into an annuity that provides retirement income. Commonly, someone with an old whole life policy they no longer need might 1035 exchange it into an annuity to avoid taxes on the cash value gains and get an income stream or long-term care rider.

• Tax outcomes: If you don’t use a 1035 and instead surrender an annuity for cash, the gain portion is taxable as ordinary income. For non-qualified annuities, gains come out first (LIFO – last-in, first-out). So usually most or all of what you receive beyond your premium is taxed. And if you’re under 59½, those taxable gains would also face a 10% early withdrawal penalty (because annuities are tax-deferred like IRAs in that sense). By using a 1035 exchange, you defer this tax further – ideally until you withdraw gradually under perhaps better conditions.

• Caution: Once you 1035 exchange, you cannot undo it. And if you exchange a life insurance for an annuity, note that life insurance gains would have been tax-free to beneficiaries upon death (as death benefit), but annuity balances are taxable to beneficiaries. So consider estate implications. Also, ensure the new contract truly fits your needs – 1035 is tax-free, but not cost-free (the new contract could have surrender charges or different fee structures).

In summary, 1035 exchanges act like rollovers for insurance contracts, allowing you to reposition assets without immediate taxes. Use a direct insurer-to-insurer process to qualify.

Pension Lump-Sum Rollovers

If you’re lucky enough to have a pension (defined benefit plan) and are given a lump-sum distribution option when you retire or leave the company, you can roll that lump sum into an IRA or other retirement plan to keep it tax-deferred. Pensions are pre-tax money, so a direct rollover of a pension lump sum to an IRA means no tax now – you’ll pay taxes only when you later withdraw from the IRA.

For example, suppose your employer offers you a $150,000 lump sum in lieu of lifetime monthly pension payments. If you take the $150k in cash, it will be fully taxable in the year you receive it (and likely push you into a high tax bracket, plus 20% mandatory withholding would apply up front). Instead, you could roll over the $150k to a traditional IRA. By doing so, you avoid immediate taxes; the entire $150k goes into the IRA and continues growing tax-deferred. You can then manage it and withdraw gradually in retirement, paying taxes then as needed (or even convert to Roth in chunks if that suits you).

Make sure to elect a direct rollover for a pension lump sum. Typically, your employer’s plan will provide forms to either cut you a check or send it to an IRA custodian of your choice. If the check is made out to “Your Bank FBO [for benefit of] Your Name IRA”, or similarly directly to the new account, it’s a direct rollover. If they issue it to you, remember the withholding rules – better to have it directly rolled.

Periodic payments note: If your pension is already in pay status as an annuity (monthly payments), those payments cannot be rolled over each time – they are just taxable pension income. Rollovers generally apply to lump sum distributions or one-time withdrawals. Some pensions let you take a lump sum of your contributions if you leave early, etc., which can be rolled over. But once you commence a lifetime annuity, those payments are simply income.

Also, qualified domestic relations orders (QDROs): if a pension (or 401k) is split by a divorce order and you as a spouse receive a portion, you often have the option to roll your share into an IRA to avoid tax (rather than taking it in cash). This is a way to handle divorce-related distributions tax-efficiently.

Inherited pensions or annuities: If you inherit an annuity or are a beneficiary of a life insurance policy payout, there are sometimes rollover-like options (for instance, a spouse beneficiary of an annuity can do a 1035 exchange into their own annuity). Non-spouse beneficiaries generally can’t “roll over” a non-qualified annuity except by continuing it as a beneficiary contract to stretch payments. For inherited qualified accounts (like an inherited IRA or 401k), different rules apply – typically you’d transfer to an inherited IRA (trustee transfer, not technically a rollover you can do yourself) to avoid immediate tax, and then take distributions per the required schedule. Non-spouse heirs cannot roll inherited IRAs into their own IRAs (they must remain inherited accounts). That’s beyond our main scope, but worth noting that spouse beneficiaries have special rollover rights (a spouse can actually roll an inherited IRA or 401k into their own IRA as if it was theirs – a unique exception that is tax-free).

Pros and Cons of Rollovers & Conversions

We’ve seen that rolling over accounts can often save you taxes in the short term (and maybe in the long term, depending on strategy). But it’s not always a one-size-fits-all decision. There are scenarios where you might not want to roll over, or you might consider converting and paying tax now for future benefits. Let’s break down some pros and cons of two major decisions: rolling over a 401(k) to an IRA, and converting traditional retirement funds to Roth. These considerations go beyond just “is it taxable” – they include other strategic factors that tie into taxes, penalties, and growth.

Rolling Over a 401(k) to an IRA: Pros & Cons

Should you roll over your employer plan to an IRA or leave it where it is (or roll into a new employer’s plan)? Here are key points:

In short, rolling over to an IRA is often beneficial for more control and potentially lower costs, but consider legal protections and special withdrawal rules you might be giving up. From a pure tax perspective, the rollover itself doesn’t cost you (if direct), but it can affect how and when you might pay taxes in the future (especially that age 55 rule or Roth conversion ease). Some people with large balances keep some money in a 401(k) to use the age-55 penalty exception for bridging early retirement, and roll over the rest to an IRA.

Converting to a Roth IRA: Pros & Cons

Deciding whether to execute a taxable rollover (conversion) to a Roth IRA involves weighing a tax hit now versus benefits later:

In essence, a Roth conversion is great if you can afford it and have a long-term outlook (or estate motive), and if you suspect equal or higher tax rates in the future. It’s costly if you convert at a high rate that could’ve been lower later. Many retirees do partial conversions in early retirement years (before Social Security or RMDs start) to “fill up” lower tax brackets – a tactical approach.

No single answer fits everyone; it’s a highly individual decision. Some people do zero conversion (especially if they expect to be in a low bracket later), others convert a lot (especially if they want to minimize RMDs or leave a tax-free legacy).

State-by-State Tax Nuances for Rollovers

For the most part, states follow the federal tax treatment on rollovers: if it’s not taxable federally, it’s not taxable on your state return either (because state taxable income usually starts from federal adjusted gross income). However, there are notable differences in certain states, especially regarding retirement income exclusions and HSA treatment. Here’s a state-by-state breakdown of any special tax nuances related to rollovers and retirement distributions:

Reading the table: If a state says “no state income tax” or “exempts retirement income,” then even if you somehow messed up a rollover and it became taxable federally, you might not owe state tax on it. Conversely, states like CA that fully tax retirement income will tax any distribution if it’s in your federal taxable income (but again, a proper rollover never hits your federal taxable income). The main standout differences are:

• States with no income tax: AK, FL, NV, SD, TX, WA, WY (and NH, TN) – no tax on any kind of income, so rollovers moot there.

• States that exempt retirement income (fully or partially): IL, MS, PA (full for retirees), IA (full for 55+), plus partial exclusions in many states as noted. In those states, even a distribution might not be taxed. For example, Illinois and Mississippi won’t tax a Roth conversion or a failed rollover distribution either, since they don’t tax retirement income at all.

• States taxing HSAs: CA and NJ – they stand out by not conforming to HSA tax benefits. No other state currently taxes HSA earnings like they do.

• State recapture on 529 rollovers: Many states (like NY, etc.) will take back deductions if you move funds out-of-state.

Always check your own state’s rules, especially if you plan a big rollover or conversion that has federal tax implications – state law could soften or exacerbate the impact.

Common Rollover Mistakes to Avoid

Even seasoned investors can trip up on rollover rules. Here are some common mistakes and pitfalls to watch out for, and how to avoid them:

• Missing the 60-Day Deadline: Procrastinating on depositing that rollover check is a classic error. Day 61 hits and now the entire distribution is taxable (and possibly penalized). Avoid this by initiating the new account deposit immediately. If mail time is an issue, remember the clock doesn’t stop – count the days. If you genuinely miss it due to circumstances beyond your control, see if you qualify for a waiver or self-certification to fix it, but that’s a last resort. It’s safer to never hold a rollover check longer than necessary.

• Taking the Money Twice (Violating One-Per-Year IRA Rollover Rule): Some folks mistakenly think they can do multiple 60-day IRA rollovers as long as each IRA only does one. That used to be a grey area, but now it’s crystal clear: one indirect IRA rollover total in any 12-month period. If you attempt a second, that second distribution will be fully taxable (and not eligible to go into another IRA). Plus, if you already deposited it, it becomes an excess contribution in the new IRA. This can cascade into multiple tax problems at once (tax on the distribution, 6% penalty per year on the excess left in the IRA). Solution: Only do one 60-day IRA rollover in any year – or stick to direct transfers which have no such limit.

• Forgetting Mandatory Withholding on Plan Distributions: If you ask for a 401(k) distribution to do your own rollover, 20% will be withheld. People sometimes forget to replace that amount when rolling over. For example, you withdraw $50,000 from your 401(k), they send you $40k (withheld $10k). You roll the $40k to an IRA and think you’re done. But that $10k not rolled is treated as a taxable distribution (and penalized 10% if you’re under 59½). This defeats the purpose of the rollover – you end up with a tax bill. Solution: Always roll over the full gross amount. If you get a partial check, use other funds to make up the difference. Better yet, do a direct rollover so nothing is withheld in the first place.

• Rolling Over Required Minimum Distributions (RMDs): By law, RMDs cannot be rolled over. Once you’re subject to RMDs (age 73+ for most accounts now), any distribution that is your RMD for the year is ineligible to rollover. Sometimes people who retire in an RMD age year try to roll their entire 401(k) to an IRA, forgetting that the year’s RMD needs to be taken out first. The proper approach: take the RMD out (pay tax on that portion), then roll the rest. If you inadvertently roll an RMD amount into an IRA, it’s considered an excess contribution in the IRA and you’ll need to remove it (with associated earnings) to avoid penalties. Solution: Keep track of RMDs and do not include them in rollover amounts.

• Not Considering After-Tax Amounts Separately: If your account has after-tax contributions, failing to handle them correctly can cost you. Say you have $5,000 of after-tax contributions in a 401(k). If you roll everything into a traditional IRA, that after-tax basis just gets mingled in the IRA (you can still track it on Form 8606 to avoid double tax, but it doesn’t grow tax-free). If instead you roll the $5k after-tax portion directly to a Roth IRA, you’d owe zero tax on that move (since it was after-tax money) and all its future earnings in the Roth will be tax-free. This is allowed and often smart. The mistake is rolling after-tax money into a traditional IRA where it doesn’t gain as much benefit. Solution: When doing rollovers, ask your plan administrator if you have after-tax contributions. Split your rollover: direct after-tax dollars to a Roth IRA, and pre-tax to a traditional IRA. This maximizes tax-free growth.

• Thinking a Direct Transfer “Doesn’t Count” and Then Doing a 60-day Rollover Too Soon: This one’s subtle. Remember, direct IRA-to-IRA transfers aren’t considered in the one-per-year rule. You could do multiple trustee transfers and they’re fine. But some people mistakenly think those transfers reset or don’t affect the 12-month clock if they then do a 60-day rollover. Example: you move IRA A to IRA B via direct transfer in March (no problem). In April, you take money out of IRA B and roll to IRA C via 60-day rollover. You might think “I haven’t done a 60-day rollover in 12 months,” which is true. But now the clock starts with this rollover. If later in the year you take money from IRA C and try to roll to IRA D, that will violate the rule. The mistake would be losing track if you’ve done one indirect rollover already because direct moves don’t count and don’t report. Solution: Keep a personal log. If you perform any 60-day rollover, mark the date and don’t do another from any IRA for the next year. Direct transfers can be done anytime, but they don’t give you extra 60-day rollover privileges.

• Misunderstanding Roth IRA 5-Year Rules Post-Conversion: If you convert funds to a Roth, be aware of a nuance: each conversion has a 5-year clock (or until age 59½, whichever comes first) before those converted funds can be withdrawn penalty-free. This is to prevent people under 59½ from converting and then immediately withdrawing to circumvent the early withdrawal penalty. If you do a conversion and then withdraw that converted principal from the Roth within 5 years, you could incur a 10% penalty (on the amount of conversion, if it was taxable, unless you’re over 59½ or an exception applies). It’s not a tax on the rollover itself, but a penalty on taking the money out too soon after. Solution: Don’t convert to Roth expecting to pull the money out right away. Roth conversions are best for money that can stay put at least five years (or until you’re of age).

• Leaving Old 401(k) Cash Uninvested After Rollover: A non-tax mistake but common: someone rolls a 401(k) to an IRA, but forgets to invest the funds once in the IRA. The money can sit in a cash sweep account not earning much. This isn’t a tax issue, but it’s a missed growth opportunity. Ensure after the rollover lands, you allocate the investments according to your plan.

• Not Reporting Indirect Rollovers Properly: Tax forms can be confusing. When you do a 60-day rollover, you’ll get a Form 1099-R showing a distribution, and a Form 5498 from the new IRA showing a rollover contribution. On your tax return, you need to report the distribution but indicate it was rolled over (so it’s not taxed). Many people forget to do that second part – they see a large 1099-R and either panic or, worse, pay tax on it unnecessarily. Solution: When filing, ensure any rollover distributions are marked as “ROLLOVER” on line 4 or 5 of Form 1040 (for IRA or pension distributions), and only the taxable amount (if any) is entered. The instructions will have you enter the full amount on one line, then zero (or the taxable portion) on the next, with “Rollover” written to the side. This tells the IRS the distribution isn’t taxable. If using tax software, answer the rollover questions carefully so it knows to exclude it from income.

• Assuming All Accounts Can Be Rolled Over: Not every account is eligible for rollover. For instance, Roth IRAs cannot be rolled into a 401(k) – 401(k) plans typically only accept pre-tax roll-ins. Non-governmental 457(b) plans can’t be rolled to an IRA. Inherited IRAs (non-spouse) can’t be combined with your own IRA – they must remain separate. If you try to do an improper rollover, the IRS will treat it as a distribution. Solution: Double-check eligibility. When in doubt, do a direct transfer institution-to-institution to avoid accidentally taking possession of funds that can’t be redeposited. And if inheriting accounts, follow specific inherited account rules – don’t try to co-mingle or rollover ineligible funds.

Avoiding these pitfalls comes down to: understand the rules or work with a financial/tax advisor who does, plan ahead, and don’t rush a rollover without double-checking the details. A little diligence can save you from costly mistakes.

Key Terms and Concepts Explained

To wrap up, let’s clarify some key rollover-related terms and entities that we’ve touched on, for better understanding:

• Rollover: In this context, a rollover is moving funds from one retirement or savings account to another, within a specified time (usually 60 days if indirect), so that the IRS treats it as a non-taxable transaction. It often involves you receiving the money and then redepositing it (indirect rollover), though colloquially even direct trustee transfers are called rollovers.

• Direct Rollover / Trustee-to-Trustee Transfer: A movement of funds directly between financial institutions or plans, without the money going to you personally. For example, when your 401(k) plan cuts a check payable to your IRA custodian (or transfers electronically). This is the safest way to preserve tax-deferred status and is not subject to the 60-day rule or withholding. Sometimes called a transfer in the context of IRAs.

• Indirect Rollover: A rollover where you temporarily take possession of the funds. You withdraw from the account, then later deposit into another account yourself. Must be done within 60 days to avoid taxes, and only allowed once per year for IRAs. Subject to 20% mandatory withholding when coming from employer plans.

• 60-Day Rule: The time limit for completing an indirect rollover – 60 days from the day after you receive the distribution. Miss it and the distribution is taxable (and penalized if early). The IRS can waive it in specific hardship scenarios or errors, via a letter ruling or via self-certification if you meet certain approved reasons (like a misplaced check, severe illness, etc., as listed in Revenue Procedure 2016-47).

• One-Per-Year Rule: The rule that you can only do one IRA-to-IRA 60-day rollover in any 12-month period across all your IRAs. Does not apply to direct transfers or to rollovers involving an employer plan (401k, etc.). Violating it causes the rollover to be invalid (taxable distribution and excess contribution).

• Eligible Rollover Distribution: This term often appears in plan literature. It refers to any distribution from a qualified plan (401k, 403b, etc.) that can be rolled over to an IRA or another plan. Most distributions qualify, except things like required minimum distributions, hardship withdrawals, certain periodic payments, and after-tax amounts if not going to a Roth. If it’s an “eligible rollover distribution,” the plan must offer the option to do a direct rollover and must withhold 20% if paid to you.

• IRS Form 1099-R: The tax form issued for distributions from pensions, 401(k)s, IRAs, etc. It shows the amount distributed and a code for the type of distribution. For rollovers, Code G in Box 7 indicates a direct rollover from a plan to an IRA or another plan (meaning not taxable). Code H is for direct rollover of a Roth 401k to a Roth IRA. Code 1, 2, 7, etc., might appear for normal or early distributions; if you rolled it over yourself, you’d still get a 1099-R (maybe Code 1 or 7 depending on age) but you’ll report the rollover on your tax return to negate it. The 1099-R is informational for you and IRS; don’t assume it means you owe tax – check the code and report correctly.

• IRS Form 5498: The counterpart form issued by IRA custodians to report contributions, including rollovers, to the IRS. It will show if you made a rollover contribution to the IRA and the amount. This comes typically in May (after tax filing) for the prior year. It’s used by IRS to cross-verify that a 1099-R distribution ended up in an IRA if claimed as a rollover.

• Pre-Tax vs. After-Tax: Pre-tax money (traditional IRA contributions, 401k deferrals, etc.) has never been taxed, so if it’s taken out not as a rollover, it’s taxable. After-tax money (non-deductible IRA contributions, after-tax 401k contributions) has already been taxed, so it’s not taxed upon distribution; only the earnings on it are. Keeping track of after-tax amounts is vital to avoid double taxation. In IRAs, you track it on Form 8606 each year. In 401ks, the plan tracks it, and it should be handled specially during rollovers (often allocated to Roth if possible).

• Basis: The portion of an account that is after-tax (already taxed) is called your basis. For example, if you contributed $5,000 after-tax to your IRA over years, that $5,000 is your basis – you don’t pay tax on it again. If you roll an account that contains basis into another, the basis carries over. Basis in a 401k after-tax rollover to a traditional IRA carries over as IRA basis (reportable on 8606). If you roll basis to a Roth, that basis becomes part of the Roth contributions (which can be withdrawn tax-free anytime).

• Taxable Rollover (Conversion): When we say a rollover is taxable, usually we mean a conversion to Roth or a rollover that missed the rules. It’s still called a rollover in conversation, but tax-wise it’s treated as a distribution (taxed) followed by a contribution to the new account. Always clarify whether a rollover will be taxable or not before executing it.

• Required Minimum Distribution (RMD): The minimum amount one must withdraw each year from retirement accounts after reaching a certain age (73 in 2023, gradually rising to 75 by 2033 under SECURE 2.0). RMDs cannot be rolled over; they must be taken as taxable withdrawals. When rolling over an account in an RMD year, take the RMD first.

• In-Service Rollover: This is when you roll over funds from a current employer’s plan while still working. Some plans allow this for those over a certain age (often 59½) or for certain sources of money (like after-tax contributions). It’s a way to move money out to an IRA or Roth IRA even before leaving the job. Tax-wise, it follows the same direct rollover rules (no tax if pre-tax money goes to IRA, tax if going to Roth, etc.).

• Plan Loan Offset Rollover: If you had a loan on your 401k and leave your job, the loan balance often becomes a taxable distribution (“loan offset”). But you can actually roll over that amount to an IRA (using other funds) to avoid tax, within a deadline (extended by recent tax law to the due date of your tax return). This is a niche scenario: basically, you repay your plan loan to an IRA within time as a rollover contribution.

• Qualified Charitable Distribution (QCD): Not a rollover, but worth mentioning: if you’re over 70½, you can transfer up to $100k from an IRA directly to a charity, and it counts toward your RMD but isn’t taxable. It’s like a rollover from your IRA to a charitable organization. Mentioning it in case someone thinks of it as a kind of rollover (it’s a transfer with special tax treatment).

• The IRS and DOL: The Internal Revenue Service (IRS) is the main body setting tax rules on rollovers. The IRS enforces the tax code (Internal Revenue Code sections 402(c), 408(d)(3), 72(t), 219, 408A, 223, etc. cover these rollover and contribution rules). The Department of Labor (DOL) also has a role for retirement plans: for instance, they require that 401k plans provide a 402(f) Notice to participants who are getting a distribution, explaining their rollover options and tax implications. (Remember the GAO finding that many people didn’t receive or understand these notices.) The DOL and IRS work together to regulate plans and protect participants.

Understanding these terms helps make sense of the rollover process and ensures you communicate clearly with plan administrators or advisors when executing a rollover.

Detailed Examples of Rollover Scenarios

Let’s walk through a couple of quick examples to see how the taxes play out:

• Example 1: 401(k) Direct Rollover to IRA – Jane leaves her job with $100,000 in her 401(k). She decides to roll it to an IRA at a brokerage. She fills out the forms for a direct rollover. Her 401(k) plan sends a check made out to “Fidelity Investments, FBO Jane’s IRA” for the full $100k. Jane deposits it into her IRA. Result: Jane gets a 1099-R for $100k with a code G (direct rollover). She won’t owe any tax or penalty. Her $100k is now in the IRA continuing to defer taxes. On her tax return, she’ll just note a rollover – the $100k is not included in taxable income at all.

• Example 2: 401(k) Indirect Rollover – Bob, age 45, has $50,000 in a 401(k) and decides to roll to an IRA but he requests the check to himself (maybe he didn’t know to do direct). The plan withholds $10,000 (20%). Bob gets a check for $40,000. He realizes he needs to roll it all, so he takes $10,000 from his savings and deposits $50,000 into an IRA within 30 days. Result: On the tax return, Bob will report the $50k distribution but then show $50k was rolled over. No tax on the $50k. The $10k withheld will count as tax paid (he’ll likely get it refunded or applied to other taxes due). If Bob had only rolled over the $40k and not replaced the $10k, then $10k would be taxable income and subject to a 10% penalty (because he’s under 59½). That would cost him $1,000 in penalty plus tax on $10k. By replacing it, he avoided that.

• Example 3: IRA to Roth Conversion – Sara has a traditional IRA worth $20,000, comprised entirely of deductible contributions and earnings (no basis). She converts the full $20k to a Roth IRA in 2025. Sara’s other income puts her in the 24% tax bracket. The conversion adds $20k to her taxable income, so she’ll owe about $4,800 in federal tax on it (24% of $20k). She’s 50 years old. Because it’s a conversion, she has no 10% penalty on that $20k. She pays the $4,800 from her checking account. In 2026, she does another $20k conversion, similarly paying tax on that. She repeats this over a few years. By retirement, she’s moved a large portion of her IRA to Roth, paid the incremental taxes, and now all those converted funds can be withdrawn tax-free forever, and she has reduced her future RMDs on the remaining traditional IRA. If Sara instead left it all in traditional, she’d owe taxes on each distribution in retirement. Converting is beneficial if her tax rate in retirement would have been >=24% or if she values the Roth features.

• Example 4: HSA rollover gone wrong – John has two HSAs and wants to consolidate. He withdraws $5,000 from HSA A. He forgets to deposit it into HSA B and uses the money for something else. 4 months later, he remembers. It’s too late – only 60 days allowed. That $5,000 is now a taxable distribution from his HSA. Because John is Fifty, it’s not used for medical, and he’s under 65, he will owe a 20% penalty as well. So $5,000 gets added to his income, plus a $1,000 penalty. Very costly oversight. Had John done a direct transfer or completed within 60 days, he’d avoid that. (And if John lived in California, he also would have paid state tax on any HSA earnings yearly anyway, since CA doesn’t treat HSA as tax-free).

• Example 5: Failing the one-year rule – Emily takes out $10,000 from her traditional IRA in January and rolls it to another IRA in February (within 60 days). In June, she takes out $5,000 from a second IRA, intending to roll it over as well. Unfortunately, because she already did one rollover in the last 12 months, this second one is not allowed. If she deposits that $5k into another IRA, it will be considered an excess contribution. The proper treatment should be: the $5,000 is taxable income to her in June (and she’s 40, so $500 penalty too). She also needs to remove the $5k (plus any interest it earned) from the IRA she put it into, to avoid ongoing 6% per year excess contribution penalties. Emily essentially has to unwind the mistake and still pay tax/penalty on that $5k distribution. Had she waited until January of next year to do the second move, or better, done a trustee-to-trustee transfer, she’d avoid this. This example shows how the IRS catches people – because each IRA reports distributions and rollovers, the IRS systems will see two rollovers in a year tied to her SSN and flag it.

These examples underscore how attention to details can save taxes. The rules, while intricate, are very logical once you break them down.

FAQs

Below are some frequently asked questions regarding rollovers and their tax implications. The answers start with a simple Yes or No, followed by a brief explanation:

Are 401(k) rollovers taxable?
No. Direct rollovers from a 401(k) to an IRA or another qualified retirement plan are not taxable events at the time of transfer. As long as the funds go directly into the new account, you won’t owe taxes on a 401(k) rollover.

Is a traditional IRA to Roth IRA rollover (conversion) taxable?
Yes. Converting a traditional IRA to a Roth IRA is a taxable rollover. You’ll owe income taxes on the amount converted (since pre-tax funds are moving into a post-tax Roth), although no early withdrawal penalty applies to the conversion itself.

Do you pay taxes on an HSA rollover?
No. Moving funds from one HSA to another via a rollover or direct transfer is not taxed federally, provided you complete it within 60 days (if it’s a rollover) and do it only once per year. (Note: CA and NJ residents will still owe state tax on HSA earnings regardless, due to state rules.)

Does a rollover count as income?
No. A properly executed rollover is not counted as taxable income. On your tax return, you report the distribution and the rollover, resulting in $0 taxable income if done correctly. It’s essentially a non-event for income purposes when fully rolled over.

Is there a limit on how much I can roll over tax-free?
No. There’s no dollar cap on rollover amounts. You can roll over any size balance without taxation, as long as it’s an eligible rollover and you adhere to the rules (e.g., time frame, one-per-year for IRAs). The only limits are on frequency and eligibility, not on the amount.

Can a rollover help me avoid the early withdrawal penalty?
Yes. If you roll over a distribution from a retirement account, you won’t incur the 10% early withdrawal penalty. The rollover essentially nullifies what would have been a withdrawal. As long as the money goes into another qualified account timely, you dodge both taxes and penalties on that distribution.

Are rollovers reported to the IRS?
Yes. Rollovers are reported. You’ll receive a Form 1099-R for the distribution and a Form 5498 for the contribution to the new account. On your tax return, you must indicate that the distribution was rolled over. The IRS uses these forms to verify that the distribution wasn’t kept as taxable income.

Can I roll over more than one IRA in a year?
No. Not via the 60-day method. You can only do one IRA-to-IRA rollover in a 12-month period. (However, Yes, you can do unlimited direct trustee-to-trustee transfers or rollovers between different types of accounts. The limit specifically applies to indirect IRA rollovers.)