Strictly speaking, there are two different ways to request an IRA rollover – an IRA direct rollover or an indirect IRA rollover. While you can choose either option, there are distinct differences between the two that you need to be aware of. For example, you’ll need to consider whether or not the tax burden that comes with an indirect rollover fits into the plans you have for your retirement investments.
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.