Know the Difference: IRA Transfer vs. Rollover

If you want to live comfortably during retirement, the time to start contributing is now. The younger you start saving for your retirement, the better chance you have to reach your goals and maintain your desired lifestyle. A great way to get started is to open an Individual Retirement Account (IRA). The next step is to fund your account, and there are three ways to do it: make a contribution, or transfer or rollover from another retirement fund. While most people understand how to make a contribution, not everyone understands the difference between a transfer and rollover, and often use the words interchangeably. So let's delve a little deeper into transfers and rollovers to see what makes them different.  

What is a Transfer?

When you move money between two separate checking accounts at different banks, you are transferring funds, and this is basically the same concept of what you can do between IRAs. A transfer is when you move money from the same type of IRA account to another.

Transferring funds between the same type of accounts is easy and can be done as often as you would like. For example, if you have a traditional IRA with one financial institution, but found a better option with another, transferring is a good idea. Maybe you are interested in diversifying your retirement portfolio by investing in real estate. If so, you may want to transfer to a self-directed IRA which allows you to invest in alternative assets, like real estate, promissory notes, or private placements. As long as you are moving between like accounts (i.e. traditional to traditional or Roth to Roth) it's considered a transfer. 

Also, when you move funds from an IRA at one firm to an IRA account managed by another firm, the transfer isn't reported to the IRS and no taxes are incurred. This is due to the fact that the money in the original IRA account never actually reached the account owner and the funds were transferred between like accounts. If the owner were to instead withdraw the funds and then reinvest them into another account, they would incur taxes upon withdrawal. There may even be tax penalties depending on why the money was taken out of the account.

What is a Rollover?

A rollover occurs when money is moved from a retirement plan (usually a 401K or other employer plan) to an IRA account. This type of rollover differs from a conventional transfer because it involves two different types of plans.

Making the decision to roll over your previous employment retirement plan into an IRA is an important one, and there are some advantages to doing so. Rolling over to an IRA allows you to move your funds from a 401K or similar account into a more flexible and potentially more beneficial IRA. When you rollover these funds into an IRA, you can maintain tax-deferred status of your retirement assets without having to pay current taxes or early withdrawal penalties.  

Direct Rollover

When the money goes directly between accounts and never reaches the account holder, this is known as a direct rollover. While this sounds a lot like a transfer, direct rollovers are different because they are reported to the IRS with two forms: the 1099R to show there was a distribution, and the 5498 to show there was a contribution back to a retirement account. They generally aren't taxable since the money was never made payable to the account holder.

Indirect Rollover

During an indirect rollover, the money is distributed to the account holder, and they have 60 days to reinvest the money into another retirement account. As long as the money is reinvested, there are no tax consequences, and the account funds will remain tax deferred, however, it will still be reportable to the IRS with the same forms as the direct rollover. When deciding between a direct or indirect rollover, the account holder should also take into consideration that indirect rollovers are limited to one per 12-month period. 

How Do I Get Started?

If you would like to initiate a transfer between like accounts, just complete the transfer paperwork with the receiving custodian and they will take it from there. For a rollover, you must contact your former employer, or their custodian, to initiate the process.

It's important to understand that the speed at which a transfer or rollover is made is dependent upon the sending custodian. This is crucial for those handling indirect rollovers to keep in mind, as penalties occur after 60 days from when the funds are distributed to the account holder. Some providers may also have specific requirements regarding rollovers that may become a factor when reallocating your funds, so make sure to factor in enough time to complete the 60-day rollover.

How Do I Know Which One to Choose?

Deciding between a transfer and rollover depends on the answers to the following questions. What's your current plan? What kind of account do you want to open? And what type of investment are you doing with the funds once they arrive? It's up to you to make the choice that's right for you. Understanding the differences between the two options will help you make an informed decision about your retirement savings, and you’ll be well on your way to reach your retirement goals. Talking with a financial advisor is recommended to get investment advice and help with tax questions.

Interested in opening a self-directed IRA, or want to learn more about how we can help? Schedule a 1-on-1 consultation with a Quest Trust Company IRA Specialist by clicking HERE.