Rollover IRA: Meaning, Overview, Special Considerations

What Is a Rollover IRA?

A rollover Individual Retirement Account (IRA) is an account that allows you to transfer assets from an old employer-sponsored retirement account to a traditional IRA. The purpose of a rollover IRA is to maintain the tax-deferred status of those assets. Rollover IRAs are commonly used to hold 401(k), 403(b), or profit-sharing plan assets that are transferred from a former employer's sponsored retirement account or qualified plan. Rollovers can also come from employer-sponsored retirement annuities such as 457 or 403(b) plans.

Rollover IRAs do not cap the amount of money an employee can roll over, and they permit account holders to invest in a wide array of assets such as stocks, bonds, ETFs, and mutual funds.

How a Rollover IRA Works

By moving retirement plan assets through a direct rollover, in which the former employer’s plan administrator moves the assets directly to the rollover IRA. This way, employees avoid having 20% of their transferred assets withheld by the Internal Revenue Service (IRS).

Alternatively, you can use an indirect rollover to move assets. In this case, you receive the funds yourself and then place them into another eligible retirement plan within 60 days. With an indirect rollover, however, 20% of the account’s assets may be withheld and cannot be recovered until you file your annual tax return.

If the movement of assets from a qualified employer-sponsored retirement plan to a rollover IRA is not handled correctly, you can face taxes. If you have not yet reached retirement age (59½), you will also pay early withdrawal penalties on those assets.

Most rollover IRAs are executed via direct (electronic) transfer or by check, though with the latter there may be a mandatory 20% withholding for federal taxes. In the case of a transfer by check, the rollover check must be deposited within 60 days. If it is deposited after 60 days, the funds will be taxed and penalties will be charged.

Special Considerations

An alternative to rolling distributions into a rollover IRA is for the employee to roll them directly into a new retirement account with a new employer. Other options include rolling assets into a traditional IRA, but this may have implications for transferring the funds to another employer’s retirement account in the future.

The rollover money can also be converted into a Roth IRA. In this case, you will have to pay taxes since qualified employer retirement plan contributions are made pre-tax and Roth IRAs hold post-tax contributions.

Rollovers to a Roth IRA

You can rollover funds from an employer-sponsored retirement account to a Roth IRA, but you will likely have to pay income tax on any pre-tax contributions you made. So if you had a traditional 401(k) account, you will likely have to pay income tax on the rollover amount. If you had a Roth 401(k), you may not have to pay taxes on the rollover, or only pay taxes on the earnings you made with investments.

Frequently Asked Questions (FAQs)

The Bottom Line

A rollover IRA can be useful when you are leaving a job and want to keep the tax advantages of a 401(k), but the right strategy for you will depend on several factors about your personal financial situation. Consider consulting a professional financial advisor for guidance on your options for transferring money from one tax-advantaged retirement account to another.