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Transferring money from an old 401(k) or IRA account to a new IRA is called a rollover. If you've changed jobs and your retirement funds are scattered across multiple accounts—or want a new IRA provider to manage all your retirement funds—a rollover IRA might be for you.
An IRA rollover allows you to transfer money from one retirement account into an IRA without penalties, income tax or capital gains taxes, but you have to complete the steps correctly to successfully avoid tax consequences. Read on to learn more about doing a successful IRA rollover.
What Is an IRA Rollover?
An IRA rollover is essentially a transfer of funds from one retirement account to another. In an IRA rollover, the money "rolls over" into an IRA from another IRA or an employer-based retirement account like a 401(k) or a 403(b). Here are a few typical reasons to do an IRA rollover:
- You've left your job and want to move your 401(k) funds into an IRA you control yourself.
- You want to move your IRA account from your current provider to a new one.
- You want to consolidate multiple IRA and 401(k) accounts into a single IRA.
Types of IRA Rollovers
IRA rollovers fall into two categories: direct and indirect.
- In a direct rollover, your IRA funds move directly from your current retirement account to your new IRA, either electronically or by check.
- An indirect rollover uses you as a middleman. Your current IRA provider sends you the funds, and you move the money into your new IRA account.
How Taxes Work on an IRA Rollover
Your IRA rollover should ultimately be tax-free whether you choose a direct or an indirect rollover. However, indirect rollovers involve a few more steps. In an indirect rollover, IRA funds are subject to 10% withholding and 401(k) funds are subject to 20% withholding when money is withdrawn.
IRA Rollover Example
Suppose you're rolling over $10,000 from an old IRA to a new IRA. If you choose an indirect transfer, your current IRA provider will send you a check for $9,000 and withhold the remainder for taxes. To roll the full $10,000 into your new account, you'll need to add $1,000 from your cash reserves—or pay income taxes and an early withdrawal penalty (if you are younger than 59½) on the $1,000 that was withheld.
Additionally, if you don't complete your indirect rollover within 60 days, the IRS may consider your entire withdrawal to be a distribution. You will owe income taxes and, again, an early withdrawal penalty if you are not yet at retirement age.
To complete an indirect IRA rollover without incurring taxes, make sure you deposit the full amount of your transferable funds into your new IRA account within 60 days. Save your transaction receipts so you can prove that you successfully completed the transfer at tax time. If you've completed the rollover steps correctly, the money that was withheld from your withdrawal will be credited to you on your tax return.
You can save yourself some stress by doing a direct rollover instead. No funds will be withheld for taxes and your money will automatically be transferred between your accounts with no danger of "accidentally" converting the money into an early retirement withdrawal.
Does a Rollover Count As a Contribution?
An IRA rollover does not count toward your annual IRA contribution limit. Regardless of how much you've rolled from one IRA account to another, you are still eligible to contribute $6,000 to your traditional or Roth IRA in 2022—$7,000 if you're 50 or older.
Separately, the IRS has a limit of one IRA-to-IRA rollover per year. You can make only one rollover from one IRA to another IRA in any 12-month period; additional IRA-to-IRA rollovers are taxable and subject to early withdrawal penalties.
Is a Rollover IRA a Good Idea?
Sometimes, a rollover IRA is a necessity. If your former employer goes out of business and their retirement plan dissolves, for example, you may be required to move your money (or lose it). The same is true if your IRA provider closes up shop.
Often, however, the decision is a little less clear. You may want to roll your retirement money into a new IRA account if your goal is to simplify your finances, for instance. If your retirement money is all in one place, you'll have an easier time tracking how much money you've saved, how your investments are performing and the diversification of your portfolio. Do you still have 401(k) funds with an old employer? Even if your relationship with your former employer is fine, you may want to cut financial ties and move on: It's just cleaner.
On the other hand, if you have special investments like preferred shares of company stock, you may want to keep your money where it is. Moving your money from an employer-based plan to an individual IRA may mean giving up the ability to borrow against your retirement investments. You may also lose creditor protection in some states if you declare bankruptcy.
Rolling your retirement money into a new IRA is a good opportunity to evaluate your retirement finances. Compare the returns and expenses associated with both your old and prospective retirement accounts and make the choice that works best for you.
How to Complete an IRA Rollover
Completing an IRA rollover is fairly simple. Just follow these basic steps:
- Open a new IRA account or confirm that an existing IRA account can accept rollover funds.
- Notify your current IRA or 401(k) provider that you would like to roll your funds into your new IRA.
- Choose a direct or indirect rollover. If you choose an indirect rollover, be prepared to accept funds into a bank account (or receive a check made out to you). You'll deposit all of this money plus the amount of any money withheld into your new account. If you choose a direct rollover, your old provider will send a check or electronic transfer directly to your new IRA administrator.
- Save records of your transactions so you can document your rollover at tax time.
Growing and Managing Your Retirement Funds
Completing an IRA rollover is as simple as following the steps, minding your timing and saving documents for tax time. Follow up by taking a proactive role in growing and managing your retirement funds in the years to come. With all your money in one place, you'll have an easier time tracking your progress and moving toward your goals.