In truth, the phrase “Rollover IRA Distribution” is a bit of a misnomer. A distribution is vastly different from a rollover and, in fact, this type of transaction really undercuts the whole process. However, there’s a way to set up a rollover from one IRA to another that preserves your retirement investments, but it must be separate from a distribution in order to maintain the tax deferred status of your savings.
As defined by the IRS, a distribution occurs when money from an IRA comes into the hands of the account holder. This event begins with a withholding of up to 20% that’s taken automatically by the account provider. Additional taxes and fees will follow after that, depending on several factors, such as how long the money remains in your hands and where it eventually winds up. But the take home message here is that a distribution is, at its heart, a taxable event and that negates the whole reason you have a retirement account in the first place.
To set up a rollover that maintains the tax deferred status of your investment, you first need an IRA rollover account to roll the money into. And although it seems simplistic, you need to make sure that the new IRA is active and ready to receive the funds you’re going to rollover. There may be a lag between the start of your employment and the activation of the account, also known as a grace period. Surprisingly, trying to rollover money before there is an account ready and able to receive the money is one of the most common IRA rollover mistakes that occur today. Fortunately, this mistake can be avoided with a simple call to the manager of the new IRA rollover account.
While you have the new manager on the phone, you can also initiate the correct rollover procedure. Tell the manager that you want to do a direct IRA rollover from the old account to the new one. Be sure to use the specific term, “direct rollover.” This will start a process wherein the manager of the new IRA will contact his or her counterpart at the old IRA and begin transferring funds between the accounts. You, as the account holder won’t ever see the funds, though you will retain the value and benefit of the money. Performing the IRA rollover in this manner maintains the tax deferred status of your money. Think of it this way – the IRS considers this type of transaction to be a reportable event, but not a taxable one.
There are, of course, other ways to move the money from one IRA to another, such as an indirect rollover, but all of these options run the risk of opening the funds up to withholding, fees and a potential tax burden for the fiscal period when transfer of funds occurred. In short, the best way to set up the IRA rollover is to use the direct rollover method.
When it comes to setting up your rollover IRA distribution account, there will be some limits as to the type of account you can establish. Some accounts, like the 457b for example, can only be established by certain types of employers. Other types, you can establish as an individual. Some IRAs, like the Simple IRA, can only be rolled over into the same type of IRA. Others are more flexible – for example, funds from a 401k account can be rolled into a traditional IRA and vice versa.
But rather than getting hung up on the particular IRS designation of your distribution account, it’s more important to choose an account that meets your needs for financial growth. Given the wide variety of options available today, it’s a good idea to meet with a financial adviser to talk about your goals for retirement savings and choose a rollover IRA account that will help you best meet those goals.