Rollover IRAs are a particular kind of individual retirement account designed for people who have changed jobs or retired and who want to transfer their 401(k)s or other retirement plan assets into a traditional or Roth IRA.
Opening a Rollover IRA will allow you to transfer assets from an old employer-sponsored retirement plan to an IRA account and maintain the tax advantages. The IRS states that “if you’re getting a distribution from a retirement plan, you can ask your plan administrator to make the payment directly to another retirement plan or to an IRA.”
Bear in mind that if you decide to roll over your plan assets into a Roth IRA, you will have to pay taxes. This is because qualified employer retirement plan contributions are made pre-tax while Roth IRAs are funded with post-tax contributions.
Rollover IRA
How does a Rollover IRA work?
Rollover IRA Explained: Moving Retirement Funds Without Tax Penalties
A Rollover IRA allows you to transfer retirement savings from a 401(k) or another employer-sponsored retirement plan into an Individual Retirement Account (IRA). This option is often used when someone leaves a job and wants to move their retirement funds while preserving their tax advantages. When done correctly, the transfer keeps the money protected from immediate taxes.
There are two main methods for moving retirement assets into a Rollover IRA: direct rollovers and indirect rollovers.
Direct Rollover
A direct rollover is usually the simplest and safest approach because it requires minimal involvement from the account holder.
In this process, you first choose the IRA provider and open an IRA account if you do not already have one. Then you request that your former employer’s retirement plan administrator transfer the funds directly to your new IRA account or send a check made payable to the IRA provider.
Because the money moves directly between financial institutions, it never passes through your personal account. This helps you avoid the 20% tax withholding that the IRS typically applies when retirement funds are distributed directly to an individual. If the check is issued in your name instead of the IRA provider’s name, you must deposit it into the IRA within 60 days to avoid taxes and potential penalties.
Indirect Rollover
An indirect rollover works differently because the funds are temporarily paid to you before being transferred to another retirement account. After receiving the distribution, you must deposit the money into another eligible retirement plan within 60 days.
However, the IRS usually withholds 20% of the distribution for tax purposes. You can recover this amount when filing your annual tax return, provided the rollover is completed correctly. If the funds are not transferred into a Rollover IRA within the required timeframe, the amount may be treated as a taxable distribution and could also trigger early withdrawal penalties.
Rollover IRA
Benefits of a Rollover IRA
The primary reason people transfer their employer-funded retirement assets to an IRA is that IRA accounts offer a wider range of investment options than most 401(k) plans.
In general, IRAs allow the accumulation of almost any type of asset: stocks, bonds, mutual funds, exchange-traded funds, certificates of deposits (CDs), etc. If you set up a self-directed IRA, the array of available investment options is even larger.
The decision whether to set up a traditional or a Roth IRA depends on how you envisage your future tax burden. The tax treatment of contributions is the main differentiator between a Roth IRA and a traditional IRA. If you expect to be in a higher tax bracket later on in your career, opening a Roth IRA may make more sense. Conversely, if your tax burden is set to decrease in the future, a traditional IRA may be a wiser solution. A rollover from a traditional 401(k) to a Roth IRA takes place in two steps: first, you roll over the money to an IRA, then you convert the account to a Roth IRA.
Rollover IRA
Rules governing rollovers
The strictest rule to bear in mind is that you generally cannot make more than one rollover from the same IRA within a 1-year period. You also cannot make a rollover during this 1-year period from the IRA to which the distribution was rolled over. Starting from January 2015, the one rollover per year applies to all of your IRA accounts in aggregate. The exceptions to the one-per-year limit are the following:
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rollovers from traditional IRAs to Roth IRAs (conversions)
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trustee-to-trustee transfers to another IRA
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IRA-to-plan rollovers
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plan-to-IRA rollovers
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plan-to-plan rollovers
Direct trustee-to-trustee transfers between IRAs are not considered distributions and thus are not subject to the once-per-year limit.