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.

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.

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.

First things first – before you can initiate an IRA direct rollover transfer, you have to establish a new account to receive your rollover funds. A 401k account can be rolled over into most types of IRA accounts, including traditional IRAs, SEP IRAs and more. The type of new account that’s best for you is something that you should discuss with your tax adviser or financial adviser. Also, be aware that there are some legislative changes taking effect in 2010 that may make direct rollover to Roth IRA a more attractive option than it has been in the past. Again, talk with your tax or financial adviser about the best type of account to set up.

Once you have your new account structure chosen and the account is open, check with the trustee or manager of that new account and find out if it is ready to receive funds.  Surprisingly enough, not all accounts are ready to receive rollover funds from day one.  Depending on the terms and structure of the new account (typically called the target account), there may be a short delay before you’re able to complete your 401k rollover to an IRA.

If your account is ready to receive a rollover, you’ll need to speak with the new account trustee about initiating an IRA direct rollover.  In a direct rollover, the trustee of your old account will send funds directly to the trustee of your new IRA rollover account for deposit.  Be sure to tell your new account trustee that you want to perform a “direct rollover of your 401k funds” into your new account using these words specifically, as this will minimize your risk of incurring federal taxes and penalties.

According to current IRA rollover rules, the new account trustee will probably have some forms for you to complete.  As far as financial transactions go, the process will be fairly painless, although you should complete the paperwork with care and review the forms before submitting them.  As with all financial transactions, it’s a good idea to keep a copy of the paperwork for your records.  Once the necessary forms are complete, the direct rollover has been initiated and will largely take place without you.  Before you know it, you’ll receive a notice that the rollover is complete.  Read the notice carefully and if anything seems amiss, contact your new account trustee immediately.

You should also expect to receive a Form 1099-R, which is a record of the IRA direct rollover transaction, from the account trustee at tax time.  A copy of this form is also filed with the IRS, as all 401k rollovers are reported to the IRS.  The good news, however, is that while this transaction must be reported to the IRS, it’s unlikely that you’ll be required to pay any income tax on this transaction.  The exception is if you’re performing a Roth IRA rollover, in which case you will be liable for regular income tax on any funds transferred.