Here’s What You Need to Know about IRA Rollovers and Transfers

Saving for retirement is good. Keeping active and ongoing tabs on your retirement savings, all in one place? Even better.

IRA rollovers allow you to move funds from an old retirement account into a rollover IRA, which can help you consolidate your nest egg and keep your investments growing.

You may have already heard about 401(k)-to-IRA rollovers, but IRA-to-IRA transfers are also an important and often-overlooked financial option, allowing savers to change their IRAs to access different investment options, perform Roth IRA conversions, and more.

However, IRA transfers of all types, including IRA-to-IRA transfers, are governed by some important rules, and understanding them can help you avoid hefty tax penalties.

Here’s the scoop.

When’s the Right Time to Open a Rollover IRA?

People choose to open rollover IRAs for a number of reasons. You might find yourself in need of a new retirement plan while changing jobs, for instance. Maybe you’re simply moving to a different IRA provider and want to have all of your savings under one roof.

Before we get too deep in the weeds, if you’re wondering about the difference between an IRA rollover vs a transfer — there really isn’t one. Both terms mean moving money from an old retirement account to a new one, though some people reserve “rollover” for instances where the two accounts are different types (for instance, from a 401(k) to an IRA).

Generally speaking, though, people often refer to even 401(k)-to-401(k) or IRA-to-IRA transfers as “rollovers,” so you don’t have to worry about the distinction too much.

But when exactly do you need to initiate this kind of transfer? Let’s take a closer look.

When to Roll Over an Old 401(k)

If you’re leaving a job, chances are you have some money saved in a 401(k) — a type of employer-sponsored retirement plan that’s funded with pre-tax contributions directly from your paycheck.

But once you clock out for the last time, those funds will simply sit there, perhaps accruing account fees out of your direct supervision. In fact, if you’ve jumped from job to job over the course of your career, as so many of us do these days, you may have multiple old 401(k)s sitting around from former employers. Too often, out of sight means out of mind — and it’s easier than you might think to lose track of your hard-earned assets.

Opening a rollover IRA allows you to consolidate your retirement funds into one account, and more actively monitor your investments in the future. (You may also be able to roll your old 401(k) into a new employer’s plan—but often, IRAs offer more flexibility on investment choices, allowing you to choose from a broad range of stock, bonds, mutual funds, ETFs, and more. Plus, you can keep your IRA no matter how many times you job-hop.)

There are plenty of good reasons to perform an IRA-to-IRA transfer, too.

When to Roll Over an Existing IRA

Even if you already have an IRA, you may want to transfer into a new one.

You might simply want to move your funds to a different financial institution or brokerage. One reason to do that could be to take advantage of different investment options or fees, since IRA providers can vary on these factors.

You might inherit an IRA from your spouse and want to incorporate that money into your existing IRA account so you — and your financial advisor — have a better picture of your joint retirement savings strategy. Investment management is a lot harder when your retirement assets are spread across many different plans! You might also want to perform an IRA conversion, moving the money from a traditional (pre-tax) IRA to a Roth (post-tax) account.

One of the biggest benefits of an IRA transfer is that they aren’t subject to the same annual contribution limits as regular IRA contributions. If you have an existing IRA and want to add money to it, the IRS says you can only put in up to $6,500 per year (or $7,500 if you’re 50 or older). But when performing a rollover, you can transfer as much as you want.

This makes an IRA transfer a great way to move a larger amount of money into a new IRA, or to establish a well-funded Roth IRA — which allows you to make withdrawals at retirement age without paying income tax (since you’ve already paid before those funds are contributed).

Note that you’ll be liable for taxes if you’re moving pre-tax contributions from a traditional IRA to an after-tax Roth account.

There are also some other important rules to keep in mind to ensure you don’t end up paying additional IRS penalty fees.

How Do You Roll Over an IRA?

There are two main ways to roll over an IRA.

• You can initiate a direct rollover, or a “trustee-to-trustee” transfer, which means plan administrator (a financial institution) holding your existing retirement funds transfers the money directly to your new IRA provider. You can also initiate a direct transfer between two accounts at the same brokerage or bank.
  • In some cases, the administrator of your old account may cut you a physical check to be deposited in the new account (sometimes a brokerage account), but because the check will be made out to your IRA, and not you as an individual, taxes won’t be withheld from the total. A direct transfer or rollover is the easiest way to roll over an IRA.
• You can also do a manual, or indirect, rollover, which means you’ll take the money from your old retirement account as a distribution and then deposit it into your new IRA on your own. However, this option comes with some additional risk.

Indirect Rollovers and the 60-Day Rule

If you elect to do an indirect rollover, you must redeposit the full amount of your old retirement balance into your new account within 60 days to keep the rollover penalty-free and avoid tax consequences. If you hold onto the money for more than 60 days, the withdrawal will be categorized as a distribution, which means it’ll be taxed like ordinary income. You’ll also be subject to the additional 10% early withdrawal penalty if you’re under the age of 59.5.

But here’s the tricky part: in most cases, the trustee of your old account is required by federal law to withhold taxes from your distribution. This means you’ll get a check that’s at least 10% (and up to 20%) lower than the account balance you had in your old retirement account. But you’re still responsible for redepositing the full amount in order to avoid income tax and early distribution penalties. Which is to say, you might have to make up the difference out of your own pocket!

Long story short: go with direct IRA transfers whenever possible!

Rollover vs. Traditional IRA

So what’s the difference between a rollover IRA and a traditional IRA? It’s kind of a trick question… because usually there isn’t one!

At the majority of IRA providers, a rollover IRA is simply a traditional IRA into which funds from another retirement account have been transferred. Because most people have pre-tax, traditional 401(k)s, rollover IRAs are also traditional IRAs that can receive those pre-tax funds.

The main difference between a rollover IRA and other types is that you can roll over as much money as you’d like into the new account, as opposed to being limited by the yearly IRA contribution maximum.

However, you’re only allowed a single rollover from one IRA to another in any given 12-month period, though this rule excludes trustee-to-trustee transfers (direct rollovers) and Roth IRA conversions.

Roth IRA Conversions

One of the most common reasons folks do IRA transfers is to initiate a Roth IRA conversion, which allows you to move money from a traditional IRA to a Roth.

However, doing so can trigger a significant tax bill, since the money in a traditional IRA is usually contributed before taxes. This allows the funds to grow tax-deferred while you strive toward your retirement goals. Only after-tax dollars can go into a Roth IRA — where, importantly, they continue to grow and can later be withdrawn tax-free.

Both types of accounts can be useful retirement assets, but the ability to take tax-free withdrawals — and avoid Required Minimum Distributions (RMDs) once you reach retirement age — make Roth IRAs (and Roth 401(k)s, for that matter) attractive to investors. That’s part of why the IRS imposes income limits on Roth accounts along with the contribution maximums that apply to both traditional and Roth IRAs.

Enter the “backdoor Roth.” Roth IRA conversions are also sometimes called “backdoor Roths,” since they allow those who surpass the IRS-prescribed income limits on who’s eligible to contribute to a Roth account. If you’re considering a backdoor Roth conversion, we recommend talking to a fiduciary or tax advisor ahead of time, as this type of rollover process may have tax implications.

No matter which of these rollover options you’re considering, keep in mind that opening a retirement plan account is not enough: you also have to make sure the funds you put in go through the allocation process! Money in a qualified retirement plan grows when investment products like stocks and bonds appreciate in value and pay interest or dividends, so be sure not to leave the money floating around in cash after your transfer. Otherwise, your retirement account is more like a savings account… except not FDIC insured.

As always, check with a qualified financial planner if you have any questions or confusion about the process.