If you’re working toward building your retirement savings and have opened an Individual Retirement Account — also known as an IRA — you may have heard the terms “IRA rollover” and “IRA transfer.” When managing your IRA account, a rollover and a transfer are two actions you can take with your retirement funds. It’s essential to understand the difference to make intelligent financial decisions, follow regulatory guidelines, and avoid taxes or penalty fees.
Here, we’ll discuss the primary differences between IRA transfers and IRA rollovers, their benefits, and when to use them in your retirement plan.
What is an IRA Transfer?
An IRA transfer is when you move your IRA account from one custodian, or financial institution, to another. As you may know, there are many types of IRAs, including traditional IRAs, Roth IRAs, SEP IRAs, and Simple IRAs.
When you attempt a transfer, your new account must be the same type of IRA—for example, you cannot transfer a Roth IRA at Bank A to a traditional IRA with Bank B. Instead, you would need to move one Roth IRA to another Roth IRA in this example.
To complete an IRA transfer, the custodian of your current IRA account will execute a direct transfer to your new IRA account, making the funds payable to that institution — not to you as an individual. You might be wondering why someone would transfer an account of the same type to another custodian, but we’ll explore that in the next section.
Top Benefits of an IRA Transfer
Why would someone want to complete an IRA transfer? Moving your IRA from one financial institution to another can offer many benefits, including:
- Moving to an account with fewer fees to save money.
- Choosing a custodian that gives you more control over your IRA investments.
- Bringing your IRA into the same financial institution where you have other savings or investments to simplify or streamline your life and finances.
Because an IRA transfer doesn’t entail changing the type of retirement account, you’ll enjoy several benefits if the transfer is completed correctly. As long as your custodian completes a trustee-to-trustee transfer, making no distribution to you as the investor, you’ll benefit from the following:
- No penalty fees: Because an IRA transfer is executed between account custodians, the money is never actually distributed to you or logged as a withdrawal. Therefore, there is no early withdrawal penalty for “early distribution”. On the flip side, you might see a penalty charge on your tax return if you try to complete an indirect IRA rollover but fail to follow the guidelines.
- No significant tax implications: Transfers are not reported to the IRS as taxable and the funds are never distributed to you, the account holder. Thus, the money will never be included on your income tax return as taxable income — though, in certain cases, it may be noted that you made a non-taxable transfer (you’d see this on a 1099-R form come tax time).
- Unlimited IRA transfers per year: Unlike IRA rollovers, which we’ll discuss later in the article, you can complete unlimited IRA transfers each year as you seek to land your account with a custodian that aligns with your goals and needs.
What is an IRA Rollover?
With an IRA rollover, you move your investment from one retirement account type to another. This is common when people change jobs, as someone may roll over their 401(k) to a traditional IRA, for example.
There are two types of IRA rollovers: direct and indirect. With a direct rollover, the 401(k) and IRA custodians manage the rollover. With an indirect rollover, the account holder (you) moves the funds, bringing extra risks and rules that must be followed.
We’ll explore the differences between direct and indirect rollovers in greater detail later in this article.
Top Benefits of an IRA Rollover
Why would someone choose to complete an IRA rollover? There are several common circumstances in which this is a smart financial move, including when you are:
- You’re in the process of changing jobs and need to keep track of former employer-sponsored retirement plans, like your old 401(k) or 403(b).
- You’re becoming self-employed and will no longer have access to an employer-sponsored plan.
- You’re adjusting your retirement strategy by changing the type of retirement account you have, and want access to different investment choices.
In these circumstances, an IRA rollover has many benefits as long as you and your account custodians follow all rules and policies:
- Generally faster than transfers: With an IRA transfer, you have to depend on your old account custodian to move the money on their timeframe, which can be slower than executing a direct IRA rollover.
- Does not require any funds to be withheld for taxes: If you opt for a direct rollover, no funds are ever distributed to you as the account holder, and so the rollover is tax-free — assuming you’re rolling the money to an account of the same tax status (i.e., pre-tax to pre-tax or Roth to Roth). With a direct rollover, you can maintain all the benefits of your tax-deferred accounts, in the case of a traditional IRA and/or pre-tax 401(k).
- Option to hold the funds for 60 days: This option is called an indirect rollover. If you attempt one, you can withdraw the funds from your old account, receive them in your bank account, and then redeposit them in a retirement account within 60 days.
- This is called the 60-day rollover rule. It allows account holders to provide themselves with a short-term loan. Be careful with this option, as it can incur potential fees and tax penalties if you don’t follow all the guidelines, or if you fail to re-deposit the money to your new retirement account within the given timeframe.
As mentioned, there are two types of IRA rollovers: direct and indirect. Below, we’ll explore the benefits and drawbacks of each option.
A direct rollover means that the funds from your existing IRA or other qualified retirement plan (such as a 401(k), Simple IRA, or 403(b)) are sent straight to your new plan without ever entering your hands.
In a way, this is similar to an IRA transfer but with different paperwork. Also similar to an IRA transfer, you never hold the money in the process, and therefore the IRS doesn’t require you to pay income tax on your tax return.
When you complete an indirect rollover, your existing retirement fund custodian distributes your retirement assets to you. Then, it’s your responsibility to deposit the funds back into either the same or a new retirement account within a 60-day timeframe. This is called the 60-day rollover rule.
Be mindful of the following rules that apply to an indirect rollover:
- Early distribution fees: If you do not re-deposit your funds into a retirement account within 60 days, you will be subject to a 10% fee on the funds, as the IRS will classify your withdrawal as an early distribution.
- Taxes: If you don’t re-deposit the funds in time, you’ll be hit with ordinary income tax on the entire amount of your failed rollover.
- As an example, if you have a $100,000 401(k) balance, and elect an indirect rollover, you’ll receive $80,000 in your bank account (gross balance less 20% tax withholding). You will need to re-deposit the full $100,000 to another retirement account within 60 days to prevent taxation.
People choose to complete an indirect rollover when they need a short-term loan and are sure they will be able to re-deposit the total sum within 60 days.
No matter the type of rollover you choose to execute, you are subject to the one-rollover-per-year rule, except for in designated circumstances outlined by the IRS. Additionally, when conducting your rollover, you should check the IRS rollover chart to ensure you are working with two compatible types of retirement accounts.