10.2 Rollovers, Roth Conversions, Recharacterizations & Qualified Plan Loans

Why This Topic Matters

Rollover questions test whether the preparer can tell a nontaxable movement of money from a taxable distribution. The same $50,000 can be completely tax-free, partly taxable, or fully taxable with a 10% additional tax depending on how it moved and how fast it was redeposited. Form 1099-R reports the gross distribution in Box 1 and a code in Box 7, but only the taxpayer knows whether a 60-day rollover was completed, so the preparer must ask.

Direct Rollovers vs. 60-Day (Indirect) Rollovers

Form 1040 reporting: The gross amount goes on Line 4a (IRAs) or 5a (pensions), the taxable amount on Line 4b or 5b, and the word "Rollover" is written next to it. A fully rolled-over distribution shows $0 taxable.

The 20% Withholding Trap

Example: Rob, age 45, leaves his job and asks for a check for his $50,000 401(k) balance. The plan must withhold 20% ($10,000) and sends him $40,000. To roll over the entire $50,000 within 60 days, Rob must deposit the $40,000 plus $10,000 of his own money. If he does, the whole distribution is nontaxable, and the $10,000 withheld is credited on his return as tax paid. If he deposits only the $40,000, the $10,000 shortfall is taxable income and is subject to the 10% additional tax ($1,000), even though it was paid to the IRS as withholding.

The One-Rollover-Per-Year Rule

Since 2015, an individual can make only one IRA-to-IRA 60-day rollover in any 12-month period, counting all of the individual's traditional, Roth, SEP, and SIMPLE IRAs together. A second indirect rollover within 12 months is a taxable distribution, and if redeposited it may be an excess contribution. The rule does not apply to:

• Trustee-to-trustee transfers between IRAs;
• Rollovers from employer plans to IRAs (or IRAs to employer plans);
• Roth conversions.

Amounts That Can Never Be Rolled Over

• Required minimum distributions (the first dollars distributed in an RMD year are treated as the RMD);
• Substantially equal periodic payments;
• Hardship distributions from a 401(k);
• Corrective distributions of excess deferrals or contributions;
• Loans treated as deemed distributions.

Missing the 60-Day Deadline

The IRS may waive the deadline. Under Rev. Proc. 2020-46, a taxpayer can self-certify a late rollover for listed reasons, such as a financial institution error, a misplaced check that was never cashed, a death in the family, serious illness, a postal error, or a home seriously damaged, if the deposit is made as soon as practicable (generally within 30 days after the reason ends). Other situations require a private letter ruling.

Roth Conversions

A conversion moves money from a traditional, SEP, or SIMPLE IRA (after 2 years), or from a pre-tax plan account, into a Roth IRA or designated Roth account.

• Taxable amount: The pre-tax portion is ordinary income in the year of conversion. If the owner has nondeductible basis, the Form 8606 pro-rata rule applies across all traditional, SEP, and SIMPLE IRAs, so the owner cannot convert only the after-tax dollars.
• No 10% tax at conversion: A direct conversion is not subject to the 10% additional tax, even under age 59½. However, each conversion starts its own 5-year clock; taking the converted amount out of the Roth IRA before 5 years and before 59½ triggers the 10% tax (see the Roth ordering rules).
• No income limit: Anyone can convert, which is why high earners use the "backdoor Roth" (nondeductible traditional contribution followed by conversion). The pro-rata rule makes that strategy partly taxable when other pre-tax IRAs exist.
• RMDs cannot be converted.

Recharacterizations

• Conversions: Since 2018 (TCJA), a Roth conversion cannot be recharacterized back to a traditional IRA. The conversion is permanent, even if the market falls.
• Regular contributions: A contribution to a traditional IRA can still be recharacterized as a Roth contribution (or vice versa) by transferring it, with its net income attributable, trustee-to-trustee by the due date of the return including extensions (October 15, 2026 for 2025). The contribution is treated as made to the second IRA from the start. This is the standard cure when a taxpayer contributes to a Roth IRA and later learns MAGI was too high.

Qualified Plan Loans (IRC §72(p))

Employer plans (not IRAs) may lend to participants. A loan is not a distribution if it meets these rules:

• Default: If the participant stops paying, the unpaid balance becomes a deemed distribution reported on Form 1099-R with Code L. It is taxable and, if the participant is under 59½, subject to the 10% additional tax. A deemed distribution cannot be rolled over.
• Loan offset at separation: If employment ends and the plan offsets the account by the unpaid loan, the offset is an actual distribution (Code M for a qualified plan loan offset). The participant can avoid tax by contributing the offset amount to an IRA or plan by the extended due date of the return for the year of the offset.
• Interest: Interest paid on a plan loan is generally nondeductible personal interest.

Example: Keisha has a $70,000 vested 401(k) balance and no prior loans. Her maximum loan is the lesser of $50,000 or 50% of $70,000 ($35,000), so $35,000. If she instead had a $15,000 vested balance, she could borrow up to $10,000 if the plan permits, because the greater of $10,000 or $7,500 is $10,000.