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.

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.

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.