What Is an IRA Rollover?
Let me explain what an IRA rollover really is. It's a straightforward transfer of funds from a retirement account, like your old employer's 401(k), into an individual retirement account (IRA). The key point here is that this move keeps the tax-deferred status of those assets intact, so you don't face immediate taxes.
You'll often see IRA rollovers used for holding assets from 401(k)s, 403(b)s, or profit-sharing plans that come from a former employer's retirement setup. It can also just be a simple IRA-to-IRA transfer if that's what you need.
Key Takeaways
- An IRA rollover lets you move funds from a retirement account to an IRA while keeping the tax-deferred benefits.
- There are direct and indirect types of rollovers, and you must follow IRS rules to steer clear of taxes and penalties.
- Direct rollovers are the most secure option since the funds go straight from one institution to another without you touching them.
- For indirect rollovers, you handle the funds yourself and must get them into the new IRA within 60 days, or you'll face taxes and penalties.
Understanding IRA Rollovers
IRA rollovers can happen from various retirement accounts, such as a 401(k), straight into an IRA, or even between IRAs. You can also roll over things like employer retirement variable annuity contracts, including 457 or 403(b) plans.
Most of the time, people do this when they switch jobs and want to shift their 401(k) or 403(b) assets into an IRA. But rollovers also make sense if you're looking to switch to an IRA that offers better features or more investment options.
Remember, there are direct and indirect types, and it's essential to stick to IRS rules so you don't end up paying unnecessary taxes or penalties.
Direct IRA Rollover
In a direct rollover, the assets move from your retirement plan to the IRA through the two financial institutions handling it. You just need to tell your plan administrator to send the funds directly to the IRA. For IRA-to-IRA transfers, the old custodian sends the amount to the new one—simple as that.
Indirect IRA Rollover
With an indirect rollover, your existing account or plan gets liquidated, and the custodian or sponsor sends you a check or deposits the funds into your personal account. Then it's on you to put that money into the new IRA.
To keep it tax-free, deposit the money in the IRA within 60 days. Miss that window, and the IRS treats it as a distribution, which could mean income taxes and an early withdrawal penalty. Generally, if you're under 59½, traditional IRA withdrawals hit you with a 10% penalty. For Roth IRAs, earnings withdrawn early usually get the 10% hit, but contributions don't. The rules are the same for IRA-to-IRA rollovers.
The IRS makes your previous employer withhold 20% if the check is made out to you, and you can't get that back until tax time. But if it's made out to the IRA, no withholding applies. For IRA distributions you plan to roll over, custodians withhold 10% unless you opt out.
Important Note on Indirect Rollovers
Some folks pick an indirect rollover to essentially take a short-term loan from their retirement account, as long as it's under 60 days.
Special Considerations
Let's talk about IRA rollover limits. The IRS caps indirect IRA-to-IRA rollovers at one every 12 months. That one-year period starts from the date of the distribution and covers traditional-to-traditional or Roth-to-Roth rollovers.
This limit doesn't touch distributions from employer plans or conversions from traditional IRAs to Roth IRAs—those are Roth conversions. Direct rollovers between IRAs also skip the one-year rule.
Watch out for tax traps. Be precise about the types of accounts involved. You can roll Roth IRA or Roth 401(k) funds to a new Roth IRA without issues, and the same goes for traditional IRA or standard 401(k) to traditional IRA. Mixing them up leads to big tax consequences because traditional accounts use pretax funds, while Roths use after-tax.
Fast Fact
Unlike 401(k) plans, IRAs let you invest in a broad range of assets like stocks, bonds, ETFs, and mutual funds.
What is a Direct Rollover?
A direct rollover means the distribution from your retirement account isn't paid to you directly. Instead, the institution holding your funds transfers it straight to your new IRA. This is the simplest way to avoid taxes and penalties.
What is an Indirect Rollover?
An indirect rollover transfers money from a tax-deferred plan to another, like an IRA, but the funds come to you first. You have to redeposit the full amount into a qualified account within 60 days to dodge taxes and penalties.
Can I Take a Loan from My IRA?
IRAs don't offer loans like many 401(k)s do, but you can borrow effectively by using the 60-day rollover rule. Withdraw assets and repay them within 60 days for what amounts to an interest-free short-term loan, all without taxes or penalties.
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