Rules & Regulations Regarding IRA Rollovers & Transfers

You may lose some of your nest egg if you do not follow IRA rollover rules.

You may lose some of your nest egg if you do not follow IRA rollover rules.

When you set up an Individual Retirement Arrangement you typically shop around for the best performing mutual fund, the certificate of deposit with the highest yield or the broker who seems to offer the best advice. However, things can quickly change. If your IRA custodian proves to be a letdown you can move your account elsewhere. The Internal Revenue Service imposes strict rules on IRA rollovers, so you may get slapped with a hefty tax bill if you do not follow the law when you move your money around.

Transfer

Many people use the terms transfer and rollover interchangeably, but as far as the IRS is concerned you should only use the word "transfer" to describe the direct movement of funds between IRA custodians. You must set up a new IRA account at a broker or bank and instruct your existing custodian to liquidate your IRA and send the cash directly to the new institution. If you have stocks and bonds in your account, you can fill out an Automated Customer Account Transfer form to have the securities sent to the new broker so you can avoid having to sell and re-purchase the securities. Since you never have access to the money, IRA transfers are not subject to time constraints, although transfers typically take up to 45 days to complete.

Rollover

When you conduct an IRA rollover, you actually withdraw your funds from your IRA account and personally deposit the money into a new IRA at another institution. You only have 60 days within which to redeposit the money. After that, the IRS treats the money as earned income for the current year and you have to pay taxes on it. Additionally, you can only conduct a rollover once in any 12 month period. Transfers, on the other hand, are unrestricted.

Traditional IRA

You can deduct the money that you invest into a traditional IRA from your taxable income, which means that you have to pay income tax on both the principal and your earnings when you withdraw from the account. You also have to pay a 10 percent tax penalty if you access your IRA funds before reaching the age of 59 1/2. If you botch your rollover, state income taxes can further erode your retirement nest egg. Depending on your tax bracket, you could lose almost half of your IRA proceeds if you hold onto your funds past the 60 day deadline. You pay nothing in taxes if you deposit the money within 60 days.

Roth IRA

Roth IRA contributions are not tax deductible, and while the same rollover rules apply, you do not have to pay any taxes or penalties on your principal if you fail to complete your rollover within 60 days. Your account earnings are subject to state and federal income tax as well as the 10 percent withdrawal penalty. However, if you do make mistakes in your Roth or traditional transfer, you can avoid the tax penalty in some situations. If you become disabled, or need the money to cover medical costs or certain educational expenses, then you do not pay the penalty. You cannot avoid ordinary income tax, however.

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