When it comes to moving funds out of your IRA and into another, the question isn’t, “Why choose an IRA direct rollover?” but instead, “Why would you choose anything BUT an IRA direct rollover?” Doing otherwise has the potential to cause great confusion, not to mention open the door to a lot of potential tax problems. That’s because, in the eyes of the IRS, a direct IRA rollover transfer is vastly different from any other kind of IRA funds transfer. And when you’re dealing with the IRS, it pays to be precise with your terminology.

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.