Rollover IRA Vs. Traditional IRA

by Dale Bye

    When you leave a job, you can benefit from taking the money from your account in a company-sponsored retirement plan, such as a 401(k), and rolling it over tax-free into an IRA. You can roll it over into an already established traditional IRA or into a rollover IRA — an account created specifically to receive the money. A rollover IRA carries the same tax rules on withdrawals, Roth conversions, and required minimum distributions as a traditional IRA, but unless you're retired and plan to stay that way, you need to understand the one key difference that might make a rollover IRA your best option.

    Reasons to Roll

    Rolling your retirement plan into either variety of IRA, traditional or rollover, typically opens up a wider assortment of investment options than what's available in a company plan. IRAs also provide lower investment costs, more withdrawal flexibility, better estate planning options, and easier required minimum distribution management than an employer-sponsored plan.

    Rollover IRA Advantage

    Choosing to create and maintain a separate rollover IRA account keeps open your option of a reverse rollover — a transfer of your rolled-over assets from the rollover IRA into a new employer's retirement plan. That provides a crucial advantage. Although the rules for company retirement plans vary on accepting rollover money, it's extremely unlikely you'll find one that allows transfers from accounts with commingled funds, such as a traditional IRA that includes rollover money, or a rollover IRA if you've added a contribution to it, even a tax-deductible one.

    Reasons to Reverse

    Reverse rollovers can prove advantageous for several reasons. For example, funds in company plans are protected by federal law from creditors and judgments. Traditional IRAs don't have federal protection, which leaves them vulnerable in many states. In addition, holding your funds in a 401(k) arrangement leaves open the possibility for penalty-free withdrawals if you leave or lose your job between ages 55 and 59 1/2. Penalty-free distributions from a 403(b) plan can begin at age 50, as long as you no longer work for the company where the account is held. By contrast, you must wait until you are 59 1/2 to take penalty-free withdrawals from either a rollover or traditional IRA.

    Roth Conversion

    You might also consider a reverse rollover to reduce the tax bite of a Roth conversion. Assets involved in an IRA-to-Roth conversion will be taxed as ordinary income except for the percentage of the IRA's value made up by after-tax contributions, but you don't get to figure the conversion only from accounts with after-tax money. IRS rules on conversions require you to include all IRA assets — including rollover IRA assets — when figuring the non-taxed portion of a conversion. Returning a rollover IRA to a workplace plan will increase your after-tax percentage, which boosts the non-taxed portion of a Roth conversion.

    About the Author

    Dale Bye has spent more than 40 years in journalism, including 25 supervising reporters and editors at metropolitan newspapers and eight years as senior managing editor at a national sports magazine. He directed five newspaper-sponsored personal finance fairs. His fields of expertise include business and personal finance, sports, fitness and theater. Bye holds a Bachelor of Journalism from the University of Missouri.

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