Traditional IRA vs .Rollover IRA

The money saved by using an IRA adds up to a lot more than just pennies.

The money saved by using an IRA adds up to a lot more than just pennies.

An Individual Retirement Account, or IRA, is a way to save money for retirement that provides significant tax advantages. There are several types of IRA accounts, each with their own features, rules and benefits. Two closely related kinds of IRAs are the traditional IRA and the rollover IRA. The differences between the two are subtle, but important.

What Is a Traditional IRA?

The first type of IRA was the traditional IRA. In fact, the official name for such an account is just IRA. All other types of IRA accounts have qualifiers in their name, such as Roth IRA ,to distinguish them from the traditional IRA. A traditional IRA offers tax-deferred growth on all investments within the account. Qualified taxpayers may also deduct the amount contributed to an IRA. In exchange, funds may not be withdrawn until the taxpayer reaches age 59 1/2, or there is a 10 percent tax penalty.

What Is a Rollover IRA?

A rollover IRA, sometimes also known as a conduit IRA, is the same as a traditional IRA in all respects. The same rules on withdrawals apply, as do the same tax benefits. Rollover IRAs are created when a person transfers money out of an employer retirement plan like a 401k, 403b or 457 plan. A rollover IRA can be changed to a traditional IRA at any time. The IRS treats all rollover IRA accounts as traditional IRAs.

What Is The Purpose of a Rollover IRA

The confusing aspect of rollover IRAs is that they are legally the same thing as a traditional IRA. In fact, a traditional IRA can be used as a rollover, or conduit, IRA. The purpose of a rollover IRA is to segregate retirement funds that may be eligible to be transferred into an employer-sponsored retirement plan, such as a 401k or 403b ,from funds that are not eligible for such transfers. Without this segregation, many retirement plans will not accept incoming transfers from an IRA. The rollover IRA designation serves as proof that all incoming funds are eligible.

When to Use a Rollover IRA

There are two common reasons to use a Rollover IRA. In one circumstance, the account owner plans to move the funds into a new employer retirement plan like a 401(k), but cannot complete the transfer in a timely fashion. For example, if the owner desires, or is required, to move money out of an existing 401k plan from a former employer, but is not yet eligible to participate in a new employer's retirement plan, the funds must be kept somewhere temporarily. Rollovers must be completed within 60 days, however. By moving the funds into a rollover IRA, you can meet the 60-day requirement. Then, the account holder can complete moving the funds into the new plan when permitted.


Photo Credits

  • Jupiterimages/BananaStock/Getty Images