What is a Rollover IRA (and What Are the Benefits)?

A rollover IRA refers to an individual retirement account that is set up to accept a transfer of money from an existing retirement account, such as a 401(k) or 403(b) plan. Sometimes, employer plans don't allow you to leave the money in the account after you've left the company, so a rollover gives you an option if you don't want to take an outright distribution.

Benefits of Rollover IRAs

When you cash out of a retirement plan, such as a 401(k) when you change employers, the money stops growing tax-free. Plus, you'll owe income taxes on the distribution and, if you're under age 59 1/2, an extra 10 percent tax on top of what you already owe. When you transfer retirement plan money to a rollover IRA, the money continues to grow tax-free, and you don't have to pay taxes on it until you take withdrawals.

Ways to Roll Over

You can roll over the money from an old retirement plan either by having it paid directly into the new IRA, or by having it paid to you and then you deposit the funds into the new IRA within 60 days. If you have the money paid to you and miss the deadline, the IRS treats the money as being permanently distributed to you. Not only do you lose the ability to have it continue to grow tax-free, you also will owe taxes and potentially early withdrawal penalties on the distributions. Plus, if you take the money out first, 20 percent is withheld for taxes. You'll get the money back when you file your taxes if you owe less, but in the meantime you'll have to come up with the extra cash to complete the rollover.

Investing Your Rollover IRA

A rollover IRA isn't a specific type of investment, it's an account that holds money that you can invest in a range of ways. Unlike a 401(k) plan, where you're limited to investing in just the options given by your company, you can pick any financial institution for your rollover IRA and pick from stocks, bonds, mutual funds, certificates of deposits and more when it comes to your rollover IRA.

Rollovers to Roth IRAs

Roth IRAs hold money that you've already paid taxes on, unlike traditional IRAs which hold money you're allowed to deduct before taxes. If the account you are rolling over the money from is a Roth account, like a Roth 401(k) or Roth 403(b), make sure you roll the money into a Roth IRA. If you have the money in a traditional 401(k) or 403(b), you're allowed to roll it into a Roth IRA, but you'll pay income taxes on the amount converted.

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