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.

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.