Getting the tax treatment of a 401(k) rollover wrong can turn a routine account transfer into a surprise tax bill. The rules are straightforward — but the indirect rollover trap catches thousands of people every year.
Rollover Tax Rules at a Glance
| Rollover Type | Taxable? | 10% Penalty Possible? |
|---|---|---|
| Traditional 401(k) → Traditional IRA (direct) | No | No |
| Traditional 401(k) → Roth IRA (direct) | Yes — full amount | No |
| Roth 401(k) → Roth IRA (direct) | No | No |
| Any 401(k) → Any IRA (indirect, within 60 days) | No (if completed fully) | No |
| Any 401(k) → distribution (missed 60 days) | Yes | Yes (if under 59½) |
The Indirect Rollover Tax Trap
When a plan sends you a check rather than transferring directly:
- The plan withholds 20% for federal income tax
- You receive 80% of your balance
- You have 60 days to deposit 100% of the original balance into an IRA
- If you can’t cover the 20% out of pocket — you owe taxes (and possibly penalty) on the withheld amount
- You get the withheld 20% back as a tax refund — but only after filing your return
Example — the $100,000 indirect rollover:
| Step | Amount |
|---|---|
| Your 401(k) balance | $100,000 |
| Plan withholds 20% | -$20,000 |
| Check you receive | $80,000 |
| Amount you must deposit in IRA within 60 days | $100,000 |
| Out-of-pocket needed to complete rollover | $20,000 |
| Withheld $20,000 returned as refund | After tax filing |
If you can only deposit $80,000, the other $20,000 is treated as a taxable distribution — and if you are under 59½, a 10% penalty applies too.
Rolling Traditional 401(k) to Roth IRA: The Tax Bill
This is a Roth conversion, and the full amount is taxable in the year of the rollover. There is no withholding penalty since you are doing a direct rollover, but you will owe taxes when you file.
Example: You roll $150,000 traditional 401(k) to a Roth IRA. You are in the 22% bracket. Your tax bill is roughly $33,000. You should either have cash available to pay this or withhold from other income — do not withhold from the rollover itself.
When a traditional-to-Roth rollover makes sense:
- You expect to be in a higher tax bracket in retirement
- You are in a low-income year (e.g., early retirement before Social Security starts)
- You have cash outside the retirement account to pay the tax bill
- You want to eliminate future RMDs on this portion of savings
After-Tax 401(k) Contributions: The Tax Treatment
If you made after-tax (non-Roth) contributions to your 401(k), those come out tax-free in a rollover. The earnings on those contributions are still taxable. Some plans separate these automatically; others require you to specify.
The optimal strategy for after-tax contributions: roll the after-tax basis to a Roth IRA (tax-free) and the pre-tax earnings to a traditional IRA. This is sometimes called the “split rollover.”
How to Report a Rollover on Form 1040
Your old plan sends Form 1099-R showing the gross distribution. You report it on your tax return:
- Line 5a: Total distribution amount (e.g., $100,000)
- Line 5b: Taxable amount (e.g., $0 for a traditional-to-traditional rollover; $100,000 for a Roth conversion)
- Write “ROLLOVER” next to line 5b if applicable
The 1099-R distribution code in Box 7 will show code G for direct rollovers. Keep your records showing the rollover was completed within 60 days if you did an indirect rollover.
For a step-by-step rollover walkthrough, see how to roll over a 401(k). To avoid costly errors, see 401(k) rollover mistakes and direct vs. indirect rollover. Return to the 401(k) Rollover Guide hub.
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