IRA Rollovers

Why Rollover an IRA

There are several reasons why an IRA account owner would want to rollover an IRA. For example, the account owner may be leaving a job and rolling over a 401(k) into an IRA. He or she may have several accounts at different financial institutions and want to keep track of all accounts on one statement. He or she may be approaching retirement and want to shift assets into less risky accounts. Or, he or she may be retired and want to shift assets into United States Treasuries or a Certificate of Deposit. Whatever the reason, account owners are allowed to rollover an IRA account once every 12 months. Provided the entire value of the amount rolled over is placed within a tax-qualified account, the status of the account will remain "tax-deferred."

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The Differences Between a Direct Rollover and Indirect Rollover

A direct rollover occurs when the full or a partial value of the account is transferred directly to the new custodian. The custodian is responsible for maintaining the account and preparing all paperwork for both the Internal Revenue Service and the account owner. If you have an IRA, you've probably noticed that your account statement lists your name and then the company name as the custodian. For example, "Charles Schwab – Custodian." An indirect rollover occurs when either part of or the full value of the account is paid to the account owner rather than directly to the new custodian.

Direct rollovers are often easier for the account owner. He or she simply fills out the appropriate forms requesting the new custodian contact the previous custodian regarding the account transfer. The previous custodian will issue a 1099 form indicating the rollover took place. But, the 1099 will not indicate that the distribution is an early distribution. The biggest benefit of a direct rollover, however, is that the account owner will not lose up to 60 days of interest or earnings that would be credited to the account. In other words, there is no loss of earnings because the money from the account was withdrawn.

If an account owner chooses an indirect rollover, he or she receives a check for the amount of the rollover. He or she then has 60 days to place the distribution into another tax-qualified account. The new account can be at a bank, a brokerage house, a mutual fund company, or any other qualified financial services company. If the account owner is under the age of 59 ½, the distribution will be recorded as an "early distribution" and will be reported to the Internal Revenue Service. Account owners are always encouraged to keep all paperwork in order to make sure that neither the early distribution penalty nor income taxes are due on the distribution.

When the account owner chooses an indirect rollover, he or she loses earnings for as long as the money is not earning a return in an account. If it takes 60 days to decide what to do with the money, some amount of tax-deferred earnings will be lost. As a result, it's generally preferable to initiate a direct rollover.

Rollover of a Traditional IRA into a Roth IRA

Technically, a traditional IRA is converted into a Roth IRA, not rolled over into one. Much has been made over the past several years about the conversion process and the tax consequences associated with it. There are no limits any longer regarding the account owners modified adjusted gross income and the ability to convert a traditional IRA into a Roth IRA. Previously, the IRS had placed a limit on the maximum amount of income an account owner could have and still cover the IRA. But, for many taxpayers, regardless of income, it often doesn't make sense to do the conversion.

When the account is converted, taxes will be due on both the contributions that were made and the earnings that have accumulated. Further, the taxes that will be due are payable in the year the account is converted. In other words, you can't pay the taxes over several years. You must pay them fully at the time the tax return for that year is filed. Unless the amount of taxes due are available in a separate account and that money isn't needed for anything else, it doesn't make sense to do the conversion if the taxes will be paid out of the IRA. It usually makes more sense to establish a Roth IRA going forward and contributing to it rather than funding an already established traditional IRA.

The amount of tax owed depends on the marginal tax bracket the owner is in when he or she converts the account. (The marginal tax rate is the amount of tax paid on the next dollar earned. In other words, does the taxpayer move into a higher tax bracket if he or she earns more money.)

How to Rollover an Annuity

Rolling over an IRA annuity is different than rolling over an IRA that contains stocks, mutual funds, bonds, or CDs. Annuities are exchanged rather than rolled over and must take place via what is known as a "1035 exchange." The account owner does not sell the annuity and does not receive the proceeds. He or she exchanges it for a new one. In other words, the 1035 functions much like a direct rollover. The owner of the annuity does not receive the proceeds of the account. The exchange takes place between the two insurance companies: the one that issued the original contract and the one that is issuing the new contract. And that's the reason annuities are exchanged. Because they are contracts, they can't simply be sold like stocks, bonds, or mutual funds. The contract must be exchanged for another if it is to remain in force.

While holding an annuity contract in a retirement account is not ideal for all investors, for some, the benefits can be substantial. In the first place, some annuities guarantee not only the principle but also the return. Some offer a "floor", below which the principle and return cannot go. Second, for retirees who have saved little for retirement, rolling an IRA into an annuity can provide income for life. While stocks, bonds, and mutual funds within an IRA account are subject to market fluctuations, a lifetime income guaranteed annuity will always pay the same amount, regardless of what's happening in the stock, bond, or credit markets.

While we've covered the basics of IRA investing here, there is much more to maximizing the success of you IRA. To make sure you're on the right track, contact a licensed financial advisor. It only takes a few minutes, Start Now.

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