IRA Rollover Rules
An Individual Retirement Account (IRA) is a specially tax advantaged retirement savings account available in the United States of America. IRAs are available in traditional (pre-tax contributions) and Roth (after-tax contributions) versions and are typically administered directly by the account holder as opposed to a custodian or trustee as is the case with other retirement plans.
When you retire or change jobs the option is available to rollover any existing retirement account(s) you have through the employer into your existing or new IRA account. Because these kind of transfers are strictly governed by the Internal Revenue Service (IRS) in order to prevent abuse, it’s vital that you know the IRA rollover rules that apply in this situation.
Cash Distribution
You can receive the funds in your 401k, 403b, 457, or other retirement plan as a check made payable directly to you. In this case you will have to pay income tax on the distribution and your former employer is required by law to hold back 20% of the distribution to ensure enough money is available to pay these taxes when you make your next tax return. An additional 10% penalty may also apply if you take the distribution as cash and you are under age fifty-nine and a half and the distribution is not used for a qualifying purpose.
Direct Rollover
A direct rollover occurs when your former employer issues a check payable to the custodian or manager of your existing or new IRA. No tax is withheld and no penalties are issued by the IRS if you choose a direct rollover. This is the most common option and the option that’s preferable if your primary aim is to get the funds in your retirement account directly into your IRA with the least amount of trouble.
Indirect Rollover
An indirect rollover is a combination of a cash distribution and a direct rollover. You can think of this option as a direct rollover with the funds being distributed to you as the custodian of your account with the understanding that you’ll take the funds and, within sixty days, deposit the entirety of the funds into an IRA or other retirement account. Like the cash distribution your former employer will withhold 20% in prepayment of taxes but this amount is returned after the bulk of the distribution is deposited into a qualifying retirement account.
The purpose of IRA rollover rules is to ensure that any funds you invested in a tax advantaged retirement account can be transferred into another tax advantaged retirement account without violating the terms of either of the accounts and potentially being penalized by the IRS.