Conduit IRA: What it Means, How it Works, Pros and Cons

What Is a Conduit IRA?

A conduit IRA is an account used to roll over funds from a qualified retirement plan to another qualified plan. Typically, the intention of using this type of individual retirement account (IRA) is to store assets until they can be rolled over into a new employer's qualified plan. A conduit IRA is also known as a "rollover IRA."

Understanding a Conduit IRA

A conduit IRA is set up by signing an IRA Plan Agreement. There is no specific provision for creating a conduit IRA. Rather, simply meeting certain rules, such as not commingling assets from another source and ensuring that the money originated from a qualifying rollover or a direct rollover from a qualified plan or 403(b), are the only requirements.

There is no limit on the sum of contributions transferred to a conduit IRA from a qualified plan, nor on the number of transactions that may be made. An individual need not contribute 100% of the assets in their qualified retirement plan to the conduit IRA.

Also, there is no time limit on a conduit IRA. Assets could reside and grow in a conduit IRA for decades and still be rolled over into a new employer's 401(k) plan. There is also no minimum length of time that assets must remain in a conduit IRA.

The Internal Revenue Service (IRS) does have some limits on rollovers, such as only allowing one rollover per year from the same IRA account. This does not apply to rollovers from traditional IRAs to Roth IRAs (conversions), trustee-to-trustee transfers to another IRA, IRA-to-plan rollovers, plan-to-IRA rollovers, and plan-to-plan rollovers.

Benefits of a Conduit IRA

The biggest benefit of a conduit IRA is the flexibility it affords an individual who has left a job and must find a place to park 401(k) assets (or assets from another qualified retirement plan). Specifically, a conduit IRA provides a way around the IRS 60-day rollover requirement.

In many cases, it takes more than 60 days to find a new job and complete the process of porting assets from one retirement plan to another. Without using a conduit or rollover IRA, an individual might receive a tax penalty for taking an early distribution.

In the last two decades, however, the need for conduit IRAs has decreased. This is primarily due to the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). The Act expanded the ability of plan-holders to port their assets, particularly allowing them to move IRA assets into eligible retirement accounts even if they did not use a conduit IRA.

Disadvantages of a Conduit IRA

For all the flexibility that conduit IRAs offer, there are some tradeoffs. For example, once assets have been transferred to a conduit IRA, no additional contributions may be made, otherwise, it ceases being a conduit.

If a conduit IRA user has no other retirement savings vehicle at their disposal, they will be unable to contribute to a tax-advantaged savings plan and may fall behind in their retirement savings goals.

Similarly, money may not be transferred into the conduit IRA from other sources otherwise it will lose its tax advantage (no longer able to accumulate capital gains tax-free and be eligible for forward averaging tax treatment).

In reality, it makes the most sense to keep a retirement account static at one place until you are ready to move it to another place, such as an employer retirement account. This removes the need and extra work of having to utilize a conduit IRA.