In order to effectively manage your retirement account, you need to understand the difference between an IRA transfer and a rollover. They differ in a number of ways, including in how the funds are handled, how reporting is done, and how taxes are applied.
As the account holder, understanding how these differ and asking a financial advisor if you have questions can help you make better decisions about your retirement accounts. You can also talk to a tax professional if you have questions about the different tax implications that might occur during this process.
Let's look at how an IRA transfer or rollover can boost your retirement funds and what each means for your future.
The Difference Between an IRA Transfer and an IRA Rollover
Many people who don't know anything about retirement accounts consider an IRA transfer and a rollover to be the same thing. However, they are not.
An IRA transfer is used to move money between the same type of retirement account. A rollover, however, is used to move money from one type of retirement account to a different type of account.
Here's an example:
You have a traditional IRA from one institution, and you want to move it to a traditional IRA at a new financial institution, you would use a transfer. This is simple since a traditional IRA is funded with pre tax money and funded with stocks, bonds, and mutual funds. Basically, it's just moving funds directly from one account to another.
However, if you want to move money from a traditional IRA plan to a gold IRA, which are different types of accounts, you would initiate a rollover.
We can go even deeper, though, and we will.
Everything You Need to Know About an IRA Transfer
Moving money from one IRA account to another is a transfer. This is done to transfer money from one financial institution to another and sometimes called a trustee to trustee transfer. The type of account doesn't change.
If you want to transfer from one retirement account, like a Roth IRA from Fidelity into a Roth IRA from Charles Schwab, nothing happens to the funds other than which company has their name on the account.
When you use a transfer like this, you don't get access to the IRA money. It is simply transferred from one company to another. Since the funds are not withdrawn, they are not taxable.
This applies to all types of IRAs, including SEP IRAs and SIMPLE IRAs. There is one exception, however, and it occurs with a SIMPLE IRA: you can transfer a SIMPLE IRA into a traditional IRA after two years from making your first contribution.
Everything You Need to Know About an IRA Rollover
A rollover is used to move funds from one IRA account to another. For instance, if you want to take money out of a traditional IRA and put it into a self directed IRA, you would use a rollover.
There are two types of rollovers, direct and indirect, and both types have tax implications. All rollovers must be reported to the IRS.
Understanding a Direct Rollover
A direct rollover is a simply way to move your funds from a retirement plan that is employer sponsored, like a 401(k) or 403(b), into an IRA or other retirement plan.
If you, for example, had an employer sponsored plan like a 403(b) from your previous employer, and you want to move those savings into an IRA, you would initiate a direct rollover. Like a transfer, your retirement savings simply move from one company to another.
Understanding an Indirect Rollover
This is where things get a little more complicated. An indirect rollover is also known as a 60-day rollover. It's the process of withdrawing funds from a retirement account, and then, within 60 days, they are deposited into another retirement account.
Here is a step-by-step guide to how indirect IRAs work:
Step #1 - Request a Distribution
To begin the process of an indirect rollover, you will need to request a distribution. Generally, you can do this by contacting the administrator of your plan.
Step #2 - The Funds are Sent
Once the administrator approves IRA distributions, you will either get a direct deposit of the funds into your bank account, or sometimes, you might get a check. If you do get a check, it must be made out to you and not the retirement account.
The IRS requires 10% - 20% of the distribution to be withheld, depending on the type of account. So, when you get the check or the direct deposit, it will be 10% to 20% less. You can get it back, however, as long as you deposit the full amount back into the new account.
Step #3 - Deposit the Funds
Once you have the money from one retirement account, you must deposit it into the new account within 60 days. Again, even though you might have gotten 10% to 20% less than the full amount, you still have to deposit the full amount. This means that you will have to use other funds to make up the 10% to 20% that was withheld.
Step #4 - Reclaim Your Withholding
Finally, as long as you deposited the full amount of your distribution into a new account, you can reclaim the withholding amount when you file your tax return. If you did not do this, any funds that were not rolled over into the new account will be considered taxable income. Additionally, if you are under the age of 59 1/2, you also may have to pay an additional 10% penalty for early withdrawal.
Rules to Keep in Mind Before You Rollover
One of the things that I always recommend before people initiate a rollover is to understand the rules that are associated with them.
You Can Only Do One Rollover Per Year
First, you can only do one indirect rollover per year. This applies to all types of IRAs. You can, however, do more than one transfer and more than one direct rollover.
You Cannot Rollover RMD
Another rule has to do with RMD, or "required minimum distribution." This is the amount that you are required by law to withdrawal from your IRA once you reach a certain age.
Employer Sponsored Plans Might Have Rules, Too
In most cases, employer sponsored plans require that you are a former employee before they allow you to remove funds from your retirement plan. Some companies offer in-service withdrawals, which would allow you to start the process.
You Only Have 60 Days to Complete an Indirect Rollover
If you take a withdrawal to do an indirect rollover, you must deposit the funds into the new account within 60 days of when the original transfer occurs. This includes the 10% to 20% withholding. If you do not make the deadline, you will be charged additional taxes as well as early withdrawal penalties.
A Note About IRA Contributions
Though transfers and rollovers are the two most popular ways to fund a self directed IRA, they are not the only way to do it. You can also make contributions.
Depending on the IRA custodian or plan administrator, you can make these contributions via check or transfer. Keep in mind that there are contribution limits, and that the IRS updates these limits each year.
If you are over the age of 50, you may be able to add more, as you can make catch-up contributions, which can boost your retirement assets.
I know this is confusing, so if you don't understand, please talk to a financial advisor or accountant for tax advice.
Frequently Asked Questions -- IRA Rollover vs Transfer
What's the main difference between an IRA transfer and a rollover?
An IRA transfer is used to move money in an IRA account from one institution to another. It's essentially a direct transfer, and you will never touch those funds, nor will you have to pay taxes on them.
A rollover is used to move funds from one type of retirement account to another. For example, you would rollover funds from a 401(k) into a Roth IRA. There are two types of rollovers.
The first type, a direct rollover, is used to move your funds from an employer plan to an IRA without having to pay any taxes.
Indirect rollovers, the second type, involve taking a short-term distributions to move funds from one account to another. If the funds are not deposited into the new fund within 60 days, there are tax consequences.
All three options have difference tax implications if they are not done in the right way, so it's best to speak to a financial advisor, IRA provider, or tax professional.
When is a transfer used and when is a rollover used?
As mentioned, a transfer and a rollover are two different things, and depending on factors like your account type, your investment strategy, and how you want to use the funds.
For example, if you have a traditional IRA, and you simply want to move to a different traditional IRA, a transfer will occur. However, if you have an old employer sponsored retirement plan with a former employer, and you want to move those funds into a self directed IRA, you would do a rollover.
What is meant by a Roth conversion? Is it the same as a backdoor Roth?
You might have seen terms like "Roth conversion" or "backdoor Roth."
A Roth conversion is a rollover from a traditional IRA or qualified retirement plan, like a 403(b), into a Roth IRA. You will still have to pay income tax on the amount that was converted, but if you are under 59 1/2, you don't have to pay the early withdrawal penalty.
In the future, distributions from the IRA will be tax-free, as long as specific conditions are met.
A "backdoor Roth IRA" is one of the investment options that people with high incomes have to contribute to their Roth IRA without having to stick to IRS income limits. Basically, the investor would place post-tax funds into a traditional IRA, and then convert those funds into a Roth IRA.
If you aren't sure if this type of strategy is right for you, I suggest speaking to a financial advisor or tax professional.
What's a rollover IRA?
A rollover IRA is simply an IRA that was funded via a rollover. For example, if you had a 401(k) and you rollover the funds into an IRA, that IRA would be referred to as a rollover IRA.
Is IRA to IRA a way to transfer funds?
As long as you are transferring funds from the same type of IRA from one financial institution into the hand of another, it is considered a transfer. For instance, if you have a traditional IRA, and you want to move the IRA funds to a different company, it is a transfer. Once it's in the new account, the other financial institution, which you used before, doesn't have any access to the account.
What are the limits on IRA transfers?
There are no limits for IRA transfers, and there are no limits on the amount you can transfer.
What are the limits on rollovers?
There is a limit of only one indirect rollover each year. This does not apply to a transfer and it doesn't apply to a direct rollover. You won't have access to the funds, so there are no tax penalties.
How is a rollover reported?
There are two things to keep in mind here.
First, the receiving institution, which is the company that receives the funds during a rollover, will report the transaction to the IRS.
The company that sent the funds will report that they did the rollover to the IRS as well. Finally, you have to report this to the IRS, too, when you fill out IRS Form 1040.
About Tim Schmidt Sr.
Tim Schmidt is an Entrepreneur and Serial Investor. Since 2012 he's been an advocate of alternative investments using a Self Directed IRA. His work has been featured in Yahoo! Finance, USA Today, Business Insider, and Tech Times, among others.
