IRA Transfer vs. Rollover: What's the Difference?
Whether you're consolidating retirement accounts, changing financial institutions, or seeking better investment options, there are moments in life that may call for moving around your IRA funds. Understanding the difference between an IRA transfer and an IRA rollover is key. Each process serves a unique purpose, and knowing which one fits your situation can help you better manage your retirement savings while avoiding unexpected taxes and restrictions.
How is an IRA Transfer Different from an IRA Rollover?
An IRA transfer and an IRA rollover serve different purposes, which are outlined in IRS rules.
An IRA transfer occurs when you move funds directly between IRAs, such as from a Roth IRA at one brokerage firm to another Roth IRA with a different brokerage firm or to a different custodian. In this case, the institution managing your account is the only thing that changes. As you do not take a distribution, IRA transfers are fast, straightforward, and tax-free.
An IRA rollover involves moving funds from one retirement account to another, either directly or indirectly. A typical example is a 401(k) to an IRA rollover, or vice versa, if your 401(k) plan allows it. Refer to IRS guidance regarding the rollover of funds from retirement plans. When rolling over retirement funds, it’s important to understand the two types:
- Direct rollover: Your current custodian sends the funds directly to your new custodian. It’s simple, fast, and avoids tax implications.
- Indirect rollover: Your current custodian sends the funds to you (often by check), and you have 60 days to deposit the full amount into the new account. You must deposit 100% of the withdrawn funds, even if a portion was withheld for taxes. If you miss the 60-day deadline, the amount may be taxed as income, and you could face penalties.
An indirect IRA rollover typically takes more time because funds are liquidated from the account before they’re sent, which can take a few days. The amount may slightly change due to market fluctuations between the request date and liquidation.
What is an IRA Conversion?
When moving retirement funds, you may also come across the term conversion, which is different from a standard rollover. In a conversion, funds are moved from one type of IRA to another type – most often, from a Traditional IRA to a Roth IRA. This is a taxable event because you are shifting pre-tax money into an after-tax account, so the amount converted is added to your taxable income for the year.
An IRA conversion can be done all at once, but many people choose to spread out the process over a few years to manage the tax impact and avoid a large tax bill in a single year. While less common than rollovers, conversions are an important tool for those who want to take advantage of a Roth IRA’s tax-free withdrawals during retirement.
What is an IRA Transfer Used For?
An IRA transfer is used to move your IRA funds from one account to another without ever taking out the money. This process is often used to either consolidate your retirement savings or to take advantage of alternative investment options. Situations in which you may need to initiate a transfer include:
- Changing financial institutions: You may want to move your IRA to an institution that provides different investment products, fees or customer service.
- Seeking different investment options: You may be interested in IRAs offering a wider range of investment opportunities, like real estate and other alternative investments.
- Consolidating accounts: As you move through life, you may find yourself wanting to transfer all of your IRAs into a single account to simplify management and fees.
- Major life events: A divorce, inheritance or planning for your legacy may all involve transferring an IRA for a variety of tax reasons.
It is important to know that an IRA transfer is typically not a taxable event, because you are not actually withdrawing any funds from the IRA. And unlike rollovers, there is no limit on the amount of IRA transfers you can complete in a given year, nor a maximum transfer amount.
What is an IRA Rollover Used For?
An IRA rollover is used when moving one type of retirement account to another, for example, when moving from an employer-sponsored plan like a 401(k) to an IRA.
Rollovers are a bit more complex than transfers, so be sure to consult IRS rules. Following are the two different types of rollovers:
- Direct rollover: The funds move from one custodian to the other. You, as the account holder, do not withdraw the funds from the account, so this type of rollover is generally not considered a taxable event but is reported to the IRS.
- Indirect rollover: The account is distributed to you as the account holder, who must then deposit 100% of the funds into another qualified retirement account within 60 days to avoid taxes and penalties. If you miss the 60-day deadline, the withdrawal may be considered a distribution by the IRS, and it may result in income tax as well as a penalty, so make sure to consult an expert prior to doing so.
How to Initiate an Indirect 60-Day Rollover
When completing an indirect rollover, otherwise known as a 60-day rollover, it’s critical to follow the steps carefully to preserve your account’s tax-advantaged status.
- Request a distribution: Start by asking your retirement plan administrator for a distribution. This can usually be done online or by contacting their office directly.
- Receive your funds: Once approved, you’ll receive the funds via check or direct deposit into your bank account. Keep in mind some distributions have a withholding for taxes.
- For IRA distributions, the option to withhold applies primarily to federal income taxes, and you can choose the percentage to be withheld.
- For 401(k) and other employer-sponsored plans, a mandatory 20% is withheld for distributions made via indirect rollovers or lump-sum withdrawals.
- Deposit funds into a new account: Within 60 days, you must deposit the full amount of the distribution (including the withheld portion) into a new retirement account.
- Reclaim the withholding: If you roll over the full distribution amount, you can recover the withheld funds when filing your tax return. However, any portion not redeposited will be taxed as income and may incur a 10% early withdrawal penalty if you’re under age 59½.
Remember, if you take a 60-day distribution from a traditional IRA and roll it over to a Roth IRA, you cannot make another rollover from any IRA for 12 months. This restriction applies to every type of indirect rollover but not to direct rollovers or transfers.
Indirect IRA Rollover: Rules and Limitations
When moving funds between two IRAs via an indirect rollover, it’s critical to understand the IRS’s one-rollover-per-year rule. This rule allows only one indirect rollover (where you receive the funds and redeposit them into another IRA) within any 12-month period. Required minimum distributions (RMDs) cannot be rolled over into another retirement account, so be sure to withdraw these amounts as required to avoid penalties. By contrast, direct transfers are not subject to the once-per-year limitation and can be done as often as needed without triggering IRS restrictions.
Zander is a seasoned product leader with a 12-year history in financial technology, specializing in private market investments. His tenure includes roles at LTSE, Alto, and IHS Markit, where he focused on product management and strategy. Zander holds an MBA from Vanderbilt University, focusing on International Business, and a B.A. in Economics from Colby College.