IRA Rollover vs. Transfer: Which Is Best?

Apr 01, 2022
IRA Rollover vs. Transfer: Which Is Best?
While saving for retirement, the terms rollover and transfer are likely to cross your path at some point in time. They both serve one purpose, to get your money into an IRA; however, they have distinct differences you should be familiar with, especially when making decisions about your retirement fund.
If you are new to investing, let’s begin with learning about what an IRA is and how it impacts your financial future.

What Is an IRA?

IRA stands for individual retirement arrangements. They are a form of investment account benefiting you when it is time to settle down and retire, replacing your current wages with a form of payment for future living expenses, travel expenses, etc.
Contributing to an IRA is the simple part to set up. Deciding on the type of IRA requires more time as they come in assorted shapes and sizes.

How To Contribute to an IRA

To obtain an IRA, consult with your financial advisor or a financial services company, such as a bank, mutual fund company, brokerage firm, etc.
Ideally, anyone can contribute to a traditional IRA as long as they are earning an income and are under the age of 70 ½. However, a Roth IRA requires that specific income requirements are met first.
When contributing to an IRA, there are limits on how much you can contribute. You can only contribute up to the annual limit mandated by Congress, or to the max amount of your annual income (if annual income is less than that of the annual limit).
In 2021, the limit is $6,000. People age 50 or older are eligible to contribute an additional $1,000, deemed as a catch-contribution.

Types of IRAs

It used to be that there was only one type of IRA to choose from. Fast forward to our world today; there are various IRA options. These include:
  • Traditional - earnings are tax-deferred while they remain in the account. At the withdrawal time, earnings are considered regular income and taxed at your current rate. Typically, contributions are tax-deductible.
  • Roth - after-tax contributions and earnings remaining tax-free as long as withdrawals are not made until you are at least 59 ½ years of age and the IRA is open for a minimum of five years.  Exclusive to the Roth IRA, you aren’t obligated to withdraw from the account and have the option to pass it down to a beneficiary of choice.
  • SEP - An IRA geared toward small business owners or self-employed individuals, mimicking a traditional IRA plan.
  • SIMPLE - stands for Savings Incentive Match Plan for Employees. SIMPLE IRAs have fewer administration costs and lower contribution limits. It is comparable to a 401(k) and is only available to small business companies with 100 employees or fewer that earn greater than $5,000 each.
  • Spousal - married to a spouse that doesn’t earn income? No problem! A spousal IRA can be opened and contributed to in addition to your own.
  • Deemed, or “Sidecar” - when your employer automatically deducts your contributions from after-tax earnings.

IRA Tax Advantages

Investing your money into an IRA provides you with tax advantages, just like other types of retirement account options. You can select from a tax-deferred IRA or a tax-free growth IRA.
If you prefer not to pay taxes upfront, a tax-deferred, traditional IRA is a good choice. It postpones taxes now, but you are responsible for paying them when it’s time to withdraw from the account.
On the other hand, a tax-free growth Roth IRA removes the future  tax liability completely, but it does have strings attached.

IRA Transfer vs. Rollover - What Is the Difference?

It might be time to consolidate your investment accounts, especially if you use multiple financial institutions. By consolidating, you minimize investment fees and set your retirement fund up for a maximized return.
Let’s unravel the differences between IRA Transfers and IRA Rollovers. With both methods, your funds are moving, but they are moving to separate places. They each have separate tax implications that can result in your paying unexpected taxes. Knowing the difference is half the battle.

What Is an IRA Transfer?

Transferring an IRA means moving your retirement savings from one IRA account to another IRA account. There are no tax implications, as it is not a transaction reported to the IRS.
Transfers are easy to initiate. Contact your financial institution and request a trustee-to-trustee transfer. This launches the paperwork process. Your funds are sent to the new financial institution of your choice in no time without added stress.
IRA transfers have no limits. You can transfer your money at your discretion any time you want.
There is one restriction, though. You can’t transfer a Traditional IRA into a Roth IRA, that is unless you initiate a Roth conversion.

What Is an IRA Rollover?

An IRA Rollover remains tax-free, assuming the rules and guidelines from the IRS are followed.
The rollover transaction occurs when money is moved from an IRA retirement account to another form of a retirement fund or vice versa.
For example, you may decide to take a 401(k) savings plan from a former employer and roll it over to an IRA. It commences when your employment ends with an employer; however, you can check with your employer to see if they offer an in-service distribution.
Do you choose to roll your retirement fund to a Traditional IRA or a Roth IRA? The answer depends on your disposition. Traditional IRAs are the easiest choice and preserve the original tax treatment from your 401(k), while Roth IRAs can minimize your future tax bill by paying the taxes now, not during retirement.
Remember, an IRA transfer does not get reported to the IRS. IRA rollovers do get reported, even if there is no tax impact. Distributions are on Form 1099-R, Box 7. If deposits are made, those are in Box 2 of Form 5498.
Unlike transfers, rollovers are restricted to one IRA to IRA rollover in 12 months. The limit does not apply to rollovers between an IRA and another eligible retirement fund. Suppose you do perform a second rollover within 12 months.
In that case, you are subject to a 10% early withdrawal penalty and a 6% annual excess contributions tax for the length of the time the retirement fund remains in the Rollover IRA.
The IRS looks at rollovers as either direct or indirect.
Direct Rollover
Your retirement fund moves from the previous employer-sponsored plan straight to a traditional IRA with a direct rollover. It is very similar to an IRA transfer, but the paperwork process is different.
Indirect Rollover
You may be familiar with the indirect rollover, also referred to as the 60-day rollover. Your retirement fund is sent directly to you for deposit with this method. At the time of distribution, 20% of the balance is withheld for federal income taxes. You can avoid the withholding by choosing a direct rollover option instead.
Per the IRS guidelines, you have 60 days to send the funds to your new IRA provider, starting from the initiated distribution date. If the funds are not deposited within this timeframe, tax implications occur, including an early distribution penalty of 10% if you are under the age of 59 ½.

Should You Choose an IRA Rollover or an IRA Transfer?

Knowing different retirement fund options and understanding the differences between an IRA transfer and an IRA rollover builds the foundation for your decision - but it doesn’t answer the underlying question. Which one do you choose?
Are you planning on making more than one transfer within the year? Then the IRA transfer may be in your best interest. It doesn’t take a lot of time to initiate the transfer, but it could slow down the availability of your fund as the processing time varies.
Rollovers are great when you need quick access to your funds. With the option to move your money directly or indirectly, you can tangibly hold your funds for up to 60 days. But, don’t hold onto your money longer than the threshold if you don’t want to risk paying taxes and penalties.

IRA Rollover vs. Transfer: The Bottom Line

Determining whether an IRA Rollover or an IRA Transfer is best for you boils down to your preference. Make an informed decision and base the facts on your investment strategy. Avoid paying penalties by following the IRS guidelines. When in doubt, consult with a financial professional. Don’t continue to walk in circles, indecisive of which route to go.
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