If you’re considering moving your IRA or a former employer’s retirement plan, there are two ways to make it happen - direct and indirect rollover. In this article, we will discuss the pros and cons of each option.
The indirect rollover is also known as the 60 day rollover. In this option, the distribution from your company’s plan is paid directly to you. You then have 60 days to deposit the money into another qualified retirement account (IRA, 401(k), etc.). The 60-day rollover clock starts the day you receive the check. If the proceeds are from a former employer’s plan, there is a mandatory 20% withholding for taxes. (For more, see: Common IRA Rollover Mistakes.)
The rollover must be completed by the end of the 60 days. To be complete, the money must be deposited into the account by the end of the period. It’s not good enough to have sent the check before the end of the period. If you miss the deadline, the entire account value will be subject to taxes. If under age 59 ½, the 10% early withdrawal penalty would apply.
If you’re transferring funds from a traditional or Roth IRA, you are limited to one IRA rollover per 12-month period. This is not measured by the calendar year. It is a 365-day period that starts the day of your first distribution. For this rule, traditional and Roth IRAs are combined. A rollover from either account type counts as the one rollover per year.
For example, John takes a distribution from an IRA and decides to roll it over in November 2017. The rollover is completed by December 2017. If John has another IRA, he has to wait until 12 months pass after the rollover in December 2017 in order to not violate the once a year rule. He would have to wait 365 days from the date the funds were deposited into the new IRA.
This is a very inefficient and complicated option with severe penalties for noncompliance.
The Direct Rollover
The direct rollover is also called the trustee to trustee transfer. It does not have the complications and limitations of the 60 day rollover. In a trustee to trustee transfer, the funds from the existing retirement account are sent directly to the custodian of the new account. In the case of a transfer of an employer plan to a new employer plan, the funds are sent directly to the trustees/custodians of the new employer plan. (For more, see: Exceptions to the 60-Day Retirement Account Rollover Rule.)
In a rollover to an IRA, money is sent directly to the IRA custodian. If sent via check, the check is made payable to XWY Company, custodian for the IRA of John. In this way, the money is not paid to the IRA or retirement account holder. As such, the 60 day rule does not apply. If coming from a company retirement plan, there is no mandatory 20% tax withholding since the money is not paid directly to the account holder. There is also no once a year limit applied to the direct rollover. You can make as many direct transfers as you want within a 12 month period.
The direct rollover rule applies to rollovers from employer plans to IRAs, from IRAs to plan rollovers and to Roth IRA conversions. Even though a Roth conversion is considered a rollover, and even if considered a 60 day indirect rollover, it does not count for the once per year rule. That rule applies only to like-to-like accounts (IRA to IRA, Roth to Roth, etc.). Since a Roth IRA is not like a traditional IRA, the rule does not apply.
In most cases, the direct rollover is the best option. There is no once per year limit, there is no tax withholding, it is less work, and much more efficient. As always, you should consider your personal situation when making this important decision. (For more, see: Guide to 401(k) and IRA Rollovers.)