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.

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.