In order to understand what the IRS thinks about direct rollovers, you need to first understand something about their first cousin – indirect IRA rollovers.  An indirect rollover occurs when the funds from your old retirement account are cashed out and put into your hands.  It doesn’t matter what your intentions are for that money.  You may intend to immediately put it into another IRA or you may have other intentions – the IRS doesn’t care.

Any time you get your hands on money from a retirement account, the door opens for withholding fees, taxes, and penalties.  Of course, there are ways to reduce – or even eliminate – these financial burdens, but the better way to manage them is to avoid them altogether.  The best way to do that is to use the IRS defined IRA direct rollover.
Basically, the IRS defines an IRA direct rollover as the transfer of money from one retirement account directly to another.  While the account holder is legally entitled to the money, he or she never gains possession of the money in a direct rollover.  This is the crucial difference.  By moving money from one retirement account directly to another, the tax-deferred status of the money is maintained (except in the case of a Roth IRA rollover).  This is the outcome that the IRS approves of, and that you, as account holder, want your money to have.  It is, after all, the reason you have retirement account in the first place.

Once you determine how much of your money you want to transfer from one account to the other, you’ll need to contact the manager of the account where you want the money to go (called the target account) and request an IRA direct rollover.  This person will then contact his or her counterpart at your old IRA or retirement account.  They will then make any necessary arrangements to transfer the money between the two accounts without your intervention.  Of course, there are some intricacies about when and how much money can be transferred, but one or both of the account managers should be able to advise you on those details.

The take home message here is that the preferred way to transfer money from a retirement account is with an IRA direct rollover.  In rare cases, there may be special terms or conditions under which you may want to perform an indirect IRA rollover, but you should do this only under the guidance of a qualified financial professional.

If you choose to have your employer make a direct rollover of an eligible rollover distribution to an IRA or another qualified plan, your avoid tax on the payment and no tax will be withheld. If you are changing jobs and want an IRA direct rollover plan of the new employer, make sure that the plan accepts rollovers; if it does not, and choose an IRA direct rollover to a traditional IRA.

When you select the IRA direct rollover option, your employer may transfer the funds directly by check or wire to the new plan, or you may given a check payable to the new plan that you deliver.

In choosing a direct rollover to a traditional IRA, the terms of the payee-employer’s plan will determine whether you may divide the distribution among several IRAs or whether you will be restricted to one IRA, For example, you may want to split up your distribution into several traditional IRAs, but the employer may force you to select only one, After the direct rollover is made, you may then diversify your holdings by making tax-free trustee-to-trustee transfer to other traditional IRAs.

You may elect to make a IRA direct rollover of part of your distribution and to receive the balance. The portion paid to you will be subject to 20% withholding and is not eligible for special averaging. The IRS allows plan administrators to bar a partial direct rollover if the rollover amount is less than $500.

An IRA direct rollover will be reported by the payer plan to the IRS and to you on Form 1099-R, although the transfer is not taxable. The direct rollover will be reported in Box I of Form 1099-R, but zero will be entered as the taxable amount in Box 2a. In Box 7, Code G should be entered if the direct rollover was to an IRA and Code H if to another qualified employer plan or to a tax-sheltered annuity.

If you work for a company that doesn’t offer an IRA program and are interested in saving for your retirement, you might want to consider opening a Roth IRA account. The Roth IRA is set up so that you can deposit income that’s already been taxed so that when you withdraw the money later in life, there’s no taxation due on the funds – all of the money you’ve saved is yours to keep.  In addition, if you have a pre-existing IRA from a previous employer or a traditional IRA that you opened on your own, you might want to consider doing a direct rollover to Roth IRA.

Since there’s a difference in the taxation rules that apply to each different type of IRA, you’ll want to go over all of the Roth IRA rollover rules with your financial advisor in order to make an informed decision on what to do with your money.  If you do decide to complete a rollover IRA withdrawal into a Roth IRA account, then you’ll have to pay taxes on the money that’s being rolled over from the traditional IRA. It’s best to complete this transaction in the form of a direct transfer in order to avoid any potential problems that may arise from handling the IRA rollover transfer money yourself.

Something else that you’ll want to do is to speak with your financial advisor about any other Roth IRA rollover rules that you may not know about that could influence your decision about whether or not to complete a traditional IRA direct rollover to Roth IRA. This way, you’ll know ahead of time what to expect from the Roth IRA rollover and can make a fully informed decision about the best possible courses of action for your finances.

In addition, there might also be IRA rollover limits that apply to you when transferring money from into a Roth IRA. For example, if you’re transferring money from a Simple IRA, the account will need to have been open for at least two years before it can be rolled over to another account.  Alternatively, you may be subject to restrictions in terms of how often you money can be transferred between accounts, especially if a rollover has occurred recently. Running your plans by your financial advisor can help to detect any of these restrictions that could affect your proposed rollover.

And while it may not seem like much up to begin with, the difference between the indirect and the direct IRA rollover transfer methods is substantial. For starters, when you rollover an IRA directly, your old account provider won’t be required to hold out the traditional 20% that’s mandated by the government when you perform an indirect transfer to cover any potential taxes that may be incurred if you fail to redeposit your funds within 60 days. With a direct transfer, you also avoid any early withdrawal penalties that may be charged if you fail to complete the rollover.

Typically, in an IRA direct rollover, the transfer occurs between the two financial institutions.  If your employer does need to send you the check for any reason, ask that it be made out directly to the new IRA account, otherwise you could run into potential problems later.  If the check is accidentally made out to you, send it back without cashing it and request that the money either be sent directly to the new account or made out to the account.

In addition, as with anything that deals with taxes, many people get confused over the IRA direct rollover process and how this impacts yearly contribution limits.  While it’s true that there is a cap on the amount that you can put into your IRA each year, this limitation does not apply to funds that are rolled over from other accounts.  This means that you could move as little as a few thousand, up to more than a million without violating the annual contribution limits.

Hopefully, your IRA direct rollover will proceed smoothly and without any problems.  However, if you have any questions or concerns about the process, be sure to contact both IRA companies in order to clear up any confusion or mistakes before they subject you to unnecessary taxes and penalties.

The first thing you need to understand is the difference between the two different kinds of transfers.  Put simply, an indirect IRA rollover is one where the money is taken from your existing IRA and issued to you (with the intention that you’ll redeposit it into a qualified retirement account).  An IRA direct rollover, on the other hand, is a transaction in which the money is moved directly from account to account, cutting you out as the middleman.

Most people choose to use a direct IRA rollover transfer because it’s easier to avoid tax penalties with this type of transaction.  When you’re issued an indirect rollover, you have sixty days to deposit the money into a rollover IRA account.  To ensure that you don’t decide to just hang on to your retirement funds, the former account manager is required to withhold 20% of your account balance to cover the taxes you’ll incur if the funds aren’t properly deposited.  These funds will only be released after you can provide proof that the monies have been correctly deposited.  With an IRA direct rollover, you won’t have to worry about any of this, as the financial institutions will handle the entire process for you.

Also, there are considerations that need to be made if you’re changing the IRA’s type during the rollover process, and it may be easier for banks to process these with a direct rollover.  For example, if you’re doing a direct rollover to a Roth IRA account from a traditional IRA, you will have to pay some taxes on the money you move, as traditional IRA contributions occur on a pre-tax basis, whereas Roth contributions are already taxed.  This is something that you may want to take into consideration and discuss with your financial advisor before deciding whether or not to do a Roth IRA rollover.

Another type of account that’s a little different than a traditional IRA is known as a Simplified Employer Pension or SEP IRA, and the although the money going into this account doesn’t need to be taxed like a Roth IRA, there are certain qualifications that you’ll need to meet.  Specifically, you can only complete a SEP IRA rollover if you’re self-employed, the owner of a small business, or an employee of a small business owner.

The best thing to do if you’re looking at doing an IRA rollover transfer is to elect an IRA direct rollover, which will leave the handling of the money and the taxation of the funds in the hands of the professionals.  Work with them to understand all of the different IRA rollover rates and programs so that you can be sure you’re doing the right thing to preserve your retirement funds.

IRA Rollover Contribution Limits

There is customarily no limit on the amount of money that can be rolled over into a Rollover IRA.  By keeping these funds separate from a regular IRA account, they are maintained apart from any regular annual contributions that you as an individual may contribute to your IRA.

All of this is important because if the contributions from an employer are mingled with personal contributions, that money cannot be rolled into another employer’s plan.  It is also important to note that money going from one type of IRA to another does not need to be reported to the IRS as taxable and is not considered a distribution.  If the account holder receives assets – meaning a portion of your money is paid to you – then the whole situation changes and the account holder is likely to have some level of tax liability.

Why Choose an IRA Direct Rollover?

The key here is that the money goes from the manager of one account to the manager of another – meaning that it’s a fund to fund transfer.  Regardless of the intention, if the money comes out of the fund to the account holder, it becomes a distribution.  To avoid any possible penalties, the exchange has to occur between the accounts.

When you fill out your IRA rollover forms, you’ll see an option to either take the account balance as a cash distribution, roll the funds directly into another IRA or move your investments to a new employer’s plan.  If you elect to take the cash distribution, you can expect to be charged an early withdrawal penalty (unless you’re over age 59 ½) and the funds you take out will be treated as regular income on your annual tax return.

How Does an IRA Direct Rollover Occur?

In most cases, an IRA rollover will occur when an employee changes jobs (assuming the rules of the fund entitle the account holder to a distribution from the old plan).  By doing an IRA rollover to a traditional IRA, the funds will be transferred tax-free.  This means that, ultimately, the funds can grow on a tax-deferred basis.  In addition, this means that the funds are under the direct control of the employee and all investment decisions and distributions will be decided by the employee.

Setting up an IRA direct rollover is relatively easy – all you need to do is set up a new IRA with the account provider of your choice and then complete some simple paperwork provided by the company.  The IRA rollover transfer will mostly take place between the two account providers, and may include sending a fund wire transfer or mailing a check to the receiving plan, the trustee or the custodian of that plan.

The general rule to always keep in mind is that like can receive like with little trouble.  For example, if you have an SEP IRA and want to move your money into a new SEP IRA rollover account, it should be a fairly simple process of signing a few IRA rollover forms.  In addition, a traditional IRA can be rolled over into almost any other type of IRA, except for a Simple IRA or a Designated Roth IRA.  In general, the rollover with the widest access to target IRAs is the Simple IRA, with one small catch – generally, you must have been participating in a Simple IRA for a minimum of two years before it can receive funds or you can rollover funds from the Simple IRA.

In addition, it’s worth mentioning the special case that exists with IRA direct rollovers from traditional IRAs to Roth IRAs.  Roth IRAs can receive funds from most other types of IRAs, but there will be tax consequences.  Roth IRAs are unlike most traditional IRAs, as they’re funded with post-tax contributions.  When you rollover pre-tax money into a Roth IRA, you’ll be required to pay taxes on the money you are contributing.

In previous years, there were few reasons to pay taxes now and move your money into a Roth IRA.  However, with the legislative changes taking effect in 2010, performing a traditional IRA rollover to Roth IRA is a much more attractive option.  These legislative changes affect not only contribution limits and income limits, but also how any taxes generated in 2010 can be paid.  If you’re interested in rolling your IRA over into a Roth IRA, talk with your tax accountant about the implications for you, both in terms of your tax bill and your investment strategy.

Once you’ve determined which types of accounts can receive your IRA direct rollover, you’ll want to be aware of a common assumption about these transfers that can lead to a mistake.  When you open a new IRA – usually when you start a new job – you may think that it’s immediately ready to receive your direct rollover.  That may or may not be the case.  The first day of employment isn’t always the day your IRA’s eligibility starts.  In some cases, there may be a delay of days, or even weeks or months.  A call to the trustee of the new IRA is the simplest way to find out if the account is ready and able to accept the rollover.

This may seem like a silly mistake, but it’s one that bears further scrutiny.  If you attempt to complete your IRA direct rollover before your account is able to receive funds, the target IRA could reject the rollover entirely, leaving you with a check for your account balance.  This moves your transaction to the realm of indirect rollovers, which could lead to significant taxes, penalties and mandatory withholding fees.

To begin the process, you’ll need to contact the manager of the new IRA – not the old one.  First, ask if the new IRA is active and ready to receive the rollover.  This may seem like an obvious question, but it’s one of the most common mistakes that occur when requesting a rollover.  The danger is that if the account isn’t ready, the money may come directly to you, which drastically changes the tax status of the money.  This is, of course, what you are trying to avoid by requesting an IRA direct rollover.

Now, once you know that the target IRA is ready to receive your funds, tell the manager that you want to perform an IRA direct rollover.  This will begin a very specific process wherein the new manager will contact his or her counterpart at the old IRA and begin to transfer the funds.  In addition to making this request, you’ll need to fill out some IRA rollover forms detailing how the transaction should occur.  Each institution will have slightly different forms, but the managers should be able to guide you as you fill them out.

Once your permission is given, the new manager will complete the request and the funds will be transferred to the new account by the most convenient means.  This may be by check or via an electronic funds transfer.  The key is that you, as the account holder, never take possession of the money.  Of course, the money technically remains your money, but it will be handled entirely by your agents, the managers of both the IRA accounts.  After a reasonable time, be sure to contact the manager of the target IRA to make sure that the IRA rollover transfer is finalized and the new funds are where they’re supposed to be.

In addition, the account managers will have to file some paperwork with the IRS, but the managers will take care of this on their own.  In some ways, this paperwork is the key to understanding why choosing an IRA direct rollover is so important.  The IRS considers an IRA direct rollover to be a reportable event, but not necessarily a taxable one.  This is what you want – an event that doesn’t require you to pay taxes, which is exactly what you’ll get with a properly executed IRA direct rollover.

There is one type of IRA direct rollover that’s slightly different – a traditional IRA rollover to Roth IRA.  This distinction occurs because, rather than contributing to a Roth IRA before taxes, you contribute to a Roth IRA after taxes.  If you are rolling over your non-Roth IRA to a Roth IRA, then taxes must be paid on that money.  This isn’t necessarily a bad thing, as your particular financial situation may make it advantageous to pay the tax burden on your retirement investments up front.

If this may be the case for you, be aware that the laws governing contributions to Roth IRAs have changed considerably in 2010.  If you’re considering an IRA direct rollover to a Roth IRA, speak with your tax accountant about how this will affect you and whether or not it’s a good choice for your investments at this time.

An indirect rollover occurs when you request the managers of your current IRA to send you the funds directly so that you can deposit that money into another retirement account.  The problem with this method is that it changes the tax burden on the money.  You must get that money into a new rollover IRA within a set time – typically 60 days – or the money will be considered a withdrawal and you will be subject to taxes, penalties and withholding.  These fees can be substantial, depending on the amount of the money involved in the IRA rollover.

In most cases, moving your money in a way that changes its tax status from tax deferred to taxable makes little sense.  After all, the reason you opened an IRA in the first place was to get out from under an immediate tax burden, while allowing your money to grow for retirement.  These kinds of accounts were set up to encourage savings and to make it easier for both employers and employees to contribute to them.  An indirect rollover runs the risk of changing this tax status that you were working so hard to maintain.

Fortunately, there is a very easy way to keep the tax deferred status that you want.  Contact the manager of the new (or target) IRA and direct him or her to perform an IRA direct rollover.  Be sure to use those exact terms – IRA direct rollover.  This specific wording will initiate a specific process where the money is sent from one IRA into the new IRA.  You will never receive a check or see the funds deposit into your bank account when you begin this type of transaction.

Although you, as the account holder, won’t ever hold the money, you will retain all the benefits of your investments when you cash out the account.  To begin the process, the manager of the target rollover IRA will contact his or her counterpart at the established IRA and make all the necessary arrangements to move the money between accounts.  The transfer may occur in the form of a wire transfer, a check or whatever instrument is most convenient.  The main thing to remember is that the money does not ever come into your hands.

The IRS considers an IRA direct rollover to be a reportable event, but not a taxable one.  For this reason, an IRA direct rollover is generally the most advantageous way to move your money.  If you choose the indirect method, you’re risking the tax status of your investments, as well as the amount you’ll lose to mandatory withholding.  Basically, you’d better have a very good reason to choose the indirect option.  If your consolidation of retirement funds is an attempt to maximize returns, doing anything other than an IRA direct rollover will defeat the whole purpose behind having an IRA.

There are three ways to get your money out of an IRA – transfer, rollover or withdrawal.  A rollover IRA withdrawal is an end game option, so to speak – this is the option you choose when you’ve reached retirement age and are ready to start reaping the benefits of years of diligent savings and investing.  Unless you’re at retirement age, withdrawals are considered premature and come with penalties and taxes, except in a few situations that the IRS qualifies as exceptions.

Transfers and IRA rollovers, on the other hand, are transactions you may elect during the life of your IRA.  Both transactions allow you to move money from an existing IRA into another.  However, the consequences of these transactions can be very different.

First, let’s address the case of the IRA direct rollover, since it’s almost always the better choice for moving your retirement funds between accounts.  Here’s where that sticky terminology issue arises again – according to IRA rollover rules, direct rollovers can also be called trustee to trustee transfers or trustee to trustee rollovers.  The key here is that your money will move directly from one IRA into another, without you or your bank account ever receiving a check.  In this case, your retirement funds will maintain their tax deferred status, and you’ll avoid any unnecessary withholding or penalties.

The other type of IRA rollover transfer, which is usually a less attractive option, is sometimes called an indirect rollover or a “payout-then-transfer” transaction.  In this case, your existing IRA is closed and you’ll receive a check.  Ideally that check will be made out to the trustee of your new rollover IRA account, and you will deposit it promptly into your new IRA.  If the check is made out to you, if you hold on to it too long, or if  you deposit it into your own personal account, then the transaction is going to look like a premature withdrawal to the IRS and you’ll open yourself up to the penalties and taxes mentioned earlier.

If you’re able to get that money into a new IRA within the IRS deadlines (typically 60 days), you may be able to avoid those penalties and taxes, although your funds will still be subject to minimum withholding requirements.  But really, why choose a needlessly complicated transaction that requires more work on your part and has even the possibility to create a potential tax burden when there is a more direct, simpler choice?  That choice is an IRA direct rollover, and chances are, it’s what your financial adviser will recommend as well.