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The Rules of Rollover IRAs

Over the lifetime of your career, you’ll probably change employers a handful of times—perhaps more often if you’re a part of the millennial generation or Gen Z. Hopefully you choose to participate in any offered employer-sponsored retirement plans—like a 401(k) or 403(b)—at each employer. And let’s say that you do, but now you’re looking at seven different investment accounts spread across different providers. Yikes!

Now you want a way to combine those funds spread across multiple employer-sponsored retirement plan accounts. Should you withdraw the money from each account and put it all into a savings account? Is there another option?

While we never discourage saving more, you should know about rollover IRAs. It could be the perfect solution for you.

What a rollover IRA is

A rollover IRA is a traditional IRA (individual retirement account) where contributed assets (funds) are invested and saved for distribution later, traditionally upon retirement (unless you’re prepared to pay a 10 percent early withdrawal fee). Usually, when you move retirement funds directly into a rollover IRA, you won’t be charged any tax penalties and those assets remain invested tax-deferred (you won’t be taxed on gains until you withdraw them—again, usually during retirement).

You can roll over part or all of another retirement account into a rollover IRA. Generally speaking, you can’t roll over funds from an active employer-sponsored retirement plan, but there are some exceptions. Ask your current employer HR rep or tax advisor for more details.

You can also continue to add money to your rollover IRA, either with annual contributions or by consolidating other former employer-sponsored retirement plan assets and IRAs.

Rollover IRA vs transfer IRA

Although the words “rollover” and “transfer” may sound interchangeable, in the eyes of the IRS and investing world, they mean different things.

A transfer is the simplest option and happens when funds are moved directly from one IRA provider to another and between like account types (traditional IRA to traditional IRA, Roth IRA to Roth IRA). The transaction isn’t reported to the IRS because you never take possession of the funds during the transfer. And, you can transfer funds between IRA accounts as many times as you want as often as you want—there are no restrictions.

If your main goal is to move an IRA from one provider to another, consider using the transfer method.

Not to make things too complicated, but there are actually two types of rollovers: direct and indirect. A direct rollover occurs when moving funds from a non-IRA account (think 40(1)k) into a traditional IRA: funds are sent directly from one provider to another, and the IRS is notified of the action. But don’t worry, this doesn’t mean you’ll pay taxes on the moved funds because you’re simply rolling them into another retirement account.

An indirect rollover, also called a “60-day rollover,” is when you take possession of the funds before putting them into the new IRA account within 60 days. This is more work as it requires you to deposit the funds into a banking account and then write a check to the new IRA provider. You must complete each of these steps in 60 days or else the IRS will tax the money as income.

Taxes

In general, you won’t have to pay taxes for completing a direct rollover, where the funds go directly from your employer-sponsored plan into a rollover IRA. If you convert any savings in your employer-sponsored retirement plan to a Roth IRA, then the conversion is subject to income tax liability.

One-rollover-per-year rule

As of January 1, 2015, you can make only one rollover from an IRA account into a rollover IRA within a one-year period. Or you can only make one rollover from an existing rollover IRA into another IRA account.

From the IRS website:

The one-per year limit does not apply to:

  • rollovers from traditional IRAs to Roth IRAs (conversions)
  • trustee-to-trustee transfers to another IRA
  • IRA-to-plan rollovers
  • plan-to-IRA rollovers
  • plan-to-plan rollovers

With this knowledge in hand, hopefully you can decide if a rollover or transfer IRA is in your best interest.

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