IRA Rollover vs. IRA Conversion

Do you have money in a 401(k) from a previous job or an old IRA? Performing an IRA rollover or conversion can be smart depending on your situation. You might also opt for an IRA transfer, where you move money between two accounts of the same type. However, none of these approaches is best in all cases. Here's how each works and how to choose between them.

Consider working with a financial advisor as you explore how best to handle your tax-advantaged accounts.

An IRA rollover refers to moving funds from one qualified retirement account to a traditional IRA. For example, you might move funds from a 401(k) or another IRA. An IRA rollover is tax-free if the money moves within 60 days of initiating the rollover. According to the IRS, you can generally only make one rollover from the same IRA within a one-year period.

The process of IRA rollover is relatively simple. In general, an IRA rollover will follow these steps:

1. Contact the IRA custodian or financial institution where the traditional IRA is held. Then, let them know you want to make a rollover.
2. Request a distribution of funds from the qualified retirement account. When doing so, ensure the distribution is payable to the IRA custodian or financial institution.
3. The IRA custodian or financial institution will deposit the funds into the traditional IRA.

IRA rollovers can be beneficial if you want to consolidate retirement accounts and want greater control over your investments.

An IRA conversion is the process of converting money held in one account into an IRA. Unlike an IRA rollover, IRA conversions are taxable events, and the amount converted is subject to income taxes in the year of the conversion.

There are two types of IRA conversions:

• Traditional IRA to Roth IRA conversion: Involves converting funds from a traditional IRA to a Roth IRA which can provide tax-free withdrawals in retirement.
• Simplified Employee Pension (SEP) or SIMPLE IRA to Roth IRA conversion: You can convert funds from a SEP or SIMPLE IRA to a Roth IRA. This can be subject to additional taxes and penalties.

The process of converting an IRA has the following steps:

1. Contact the IRA custodian or financial institution where the traditional IRA is held. Let them know you want to make a conversion.
2. Request a conversion of funds from the traditional IRA to the Roth IRA.
3. The IRA custodian or financial institution will deposit the converted funds into the Roth IRA.
4. Report the converted amount as income on the tax return for the year in which the conversion is completed.

There are several differences between IRA rollovers and IRA conversions. In general, these differences come down to factors like taxes, eligibility, timing, and investment options. IRA rollovers are usually tax free, assuming the rollover is completed within 60 days from its initiation.  However, IRA conversions are generally taxable with the amount converted subject to income taxes in the tax year of the conversion. The two also differ in eligibility: IRA rollovers are typically available to anyone with a qualified retirement plan. On the other hand, IRA conversions have income limits that may restrict eligibility.

Another difference between IRA rollovers and IRA conversions is in their timing. IRA rollovers must be completed within 60 days of the distribution from the qualified retirement account. However, IRA conversions can be completed at any time.

Lastly, IRA rollovers and IRA conversions may have different investment options. Traditional IRAs, which are typically used in IRA rollovers, may offer a wider range of investment options compared to Roth IRAs used in an IRA conversion.

Another decision you might have to make is between a direct IRA rollover and a trustee-to-trustee rollover. Both methods move retirement funds from one account to another without incurring taxes or penalties. However, there are some key differences between the two:

1. Initiation: With a direct IRA rollover, the owner initiates the rollover by requesting the distribution from the current custodian and specifying the new custodian. With a trustee-to-trustee IRA rollover, the current custodian initiates the transfer by sending the funds directly to the new custodian.
2. Required Minimum Distributions (RMDs): With a direct IRA rollover, the account owner must first take required minimum distributions (RMDs) before initiating the transfer. With a trustee-to-trustee IRA rollover, the RMD can be taken at any time during the year. This includes the time after the transfer occurs.
3. Fees: With a direct IRA rollover, the account owner may be subject to fees from the current custodian for closing the account. With a trustee-to-trustee IRA rollover, there are typically no fees.
4. Timing: With a direct IRA rollover, the account owner receives the funds and has 60 days to deposit them into the new IRA account. With a trustee-to-trustee IRA rollover, the funds are transferred directly between custodians and the account owner never takes possession of the funds. Thus, there is concern about timing with a trustee-to-trustee rollover.
5. Number of rollovers per year: With a direct IRA rollover, an account owner can generally only perform one rollover per year. With a trustee-to-trustee IRA rollover, there are no limits on the number of rollovers that can be performed.

Generally, whether you should choose an IRA rollover or a conversion comes down to their differences. For instance, converting a traditional IRA to a Roth IRA may be ideal for high-net-worth individuals. This is because it may allow tax-free withdrawals in retirement. Conversely, someone who expects to be in a lower tax bracket in retirement might prefer a rollover, which may provide tax-deferred growth.

Investment options are also an important factor to consider. Traditional IRAs used in a rollover may offer a wider range of investment options than Roth IRAs used in a conversion. Individuals who want greater control over their investment options may prefer an IRA rollover. However, those who are comfortable with a more limited range of investment options may prefer IRA conversion.

There is also the consideration of required minimum distributions (RMDs). RMDs are required for traditional IRAs starting at age 72, while Roth IRAs are not subject to RMDs. Individuals who want to delay RMDs may prefer an IRA rollover, while those who want to avoid RMDs altogether may choose an IRA conversion.

When deciding between IRA rollover and an IRA conversion, it's important to consider one's personal tax situation, eligibility, investment options, RMDs, and timing. It's also important to consult with a financial professional to determine the most suitable strategy based on one's individual circumstances and goals. The bottom line is that the choice between an IRA rollover and an IRA conversion depends on many factors unique to everyone and it's important to carefully consider all options before deciding.

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