When leaving a job, one term you might encounter is a “rollover IRA.” But what exactly are the benefits of an IRA rollover? When an employee exits their employer-sponsored 401(k) plan, they often have the option to transfer their retirement funds into an individual retirement account (IRA) at another financial institution. This process is called a rollover, and the resulting account is known as a rollover IRA. For most individuals, a standard IRA is suitable unless their 401(k) plan was a Roth 401(k).
While rollover IRAs are like traditional IRAs, there are key differences. A traditional IRA doesn’t necessarily have to originate from a rollover. To better understand these distinctions, let’s explore the nuances between a traditional IRA and a rollover IRA.
Key Points
- Employees often roll over funds from a qualified retirement plan, like a 401(k), into an individual retirement account (IRA) upon leaving a job.
- Contributions to a traditional IRA are subject to eligibility restrictions and may be tax-deductible up to a certain limit.
- Commingling funds—mixing rollover funds with direct contributions—can complicate future transfers of funds to a new employer’s plan.
- Withdrawals from either type of IRA before age 59½ are subject to income taxes and an early withdrawal penalty, with some exceptions.
- At age 73, required minimum distributions (RMDs) must begin for both traditional and rollover IRAs.
What Is the Difference Between a Traditional IRA and a Rollover IRA?
The primary distinction lies in the origin of the funds. A rollover IRA is funded by transferring assets from an employer-sponsored retirement plan, while a traditional IRA typically consists of direct contributions. Both accounts follow the same tax rules for Roth conversions, RMDs, and withdrawals.
What Are the Benefits of a Rollover IRA?
A rollover IRA is an individual retirement account created by transferring funds from a qualified retirement plan, such as a 401(k) or 403(b). Here are the main advantages of choosing a rollover IRA:
- Tax-Deferred Growth: Just like a traditional IRA, funds in a rollover IRA grow tax-free until withdrawal.
- Lower Fees: Compared to many 401(k) providers, IRAs often come with reduced fees, potentially saving you money over time.
- Broader Investment Options: IRAs typically offer a wider range of investment opportunities than employer-sponsored plans.
- Simplified Account Management: A rollover IRA allows you to consolidate multiple retirement accounts into one, streamlining your portfolio.
- Early Withdrawal Flexibility: Certain qualified expenses, such as a first home purchase or college tuition, may allow for penalty-free withdrawals, though income taxes still apply.
Potential Drawbacks of a Rollover IRA
Despite its benefits, a rollover IRA may have some limitations compared to employer-sponsored plans:
- No Loan Options: Unlike 401(k) plans, you cannot borrow against a rollover IRA.
- Restricted Investment Options: Some unique investment opportunities available in your 401(k) may not be accessible in an IRA.
- Tax Implications for Company Stock: Rolling over company stock can lead to unfavorable tax consequences.
- Creditor Protections: Employer-sponsored plans often have stronger protections against creditors than IRAs, depending on state laws.
- Required Minimum Distributions (RMDs): At age 73, RMDs are mandatory for IRAs, while employer plans may allow you to delay RMDs if you’re still employed.
What Is a Traditional IRA?
A traditional IRA is a retirement savings account that allows tax-deferred growth on investments. Contributions to a traditional IRA may be tax-deductible, depending on your income and participation in an employer-sponsored retirement plan. This can benefit retirees who find themselves in a lower tax bracket, as they’ll pay less in taxes upon withdrawal.
Can You Contribute to a Rollover IRA?
Yes, contributions to a rollover IRA are allowed up to the IRA contribution limits. For 2023, the limit is $6,500, with an additional $1,000 for those aged 50 or older. However, adding non-rollover funds to a rollover IRA may restrict your ability to transfer those funds to a future employer’s retirement plan.
Can You Combine a Traditional IRA with a Rollover IRA?
Yes, you can merge funds from a traditional IRA and a rollover IRA. This can be done via direct transfer or a rollover, but it’s crucial to complete the transfer within 60 days to avoid penalties. Note that commingling funds may affect your ability to roll the account into a future employer’s plan.
Conclusion
The differences between a traditional IRA and a rollover IRA are minimal, yet significant when considering your retirement strategy. Both account types provide tax-advantaged growth, but with portfolio rebalancers like UREBAL you can be sure they guide your choice accordingly.
If you plan to make regular contributions to your IRA, consider whether you might need to roll those funds into a future employer’s plan. Regardless of your decision, both traditional IRAs and rollover IRAs can serve as valuable tools for building a secure financial future.