It can be challenging to find the money to set aside for your retirement, so it’s important to take advantage of all the tax advantages offered by the government to maximize your retirement nest egg. Traditional IRAs offer tax-deferred savings, which means the money isn’t taxed when you make contributions, but you’ll pay taxes on the distributions. You can set up a traditional IRA on your own without an employer. But, if your employer offers a retirement plan option, like a 401(k) or 403(b), you might have your nest egg split among multiple plans. A rollover IRA is simply a traditional IRA that contains the money that has been rolled over from an employer plan.
Rollover IRA Options
Usually, you are not able to take money out of your 401(k) plan when you’re still employed. But, after you change jobs or retire, many people want to take their money with them rather than leaving it in their old company’s plan. If you were to take the money out of the retirement account, you would be hit with income taxes on the distribution and have to pay a 10-percent early withdrawal penalty if you’re under 59-½-years-old.
Instead, the Internal Revenue Service allows you to roll the money into an IRA to maintain the tax-deferred growth until you need the money in retirement. You can perform either a direct rollover, where the money is directly transferred from your employer plan to your traditional IRA without being paid to you first, or a 60-day rollover, where the money is paid to you and then within 60 days you redeposit the money in a traditional IRA.
Asset Protection for Certain Rollover IRAs
Both IRAs and employer-sponsored retirement plans, like 401(k)s and 403(b)s, offer some level of asset protection, but they’re not equal. Typically, if you declare bankruptcy, traditional IRAs are only protected up to $1,362,800 while employer-sponsored plans are completely exempt from creditors. So, if you roll your 401(k) or 403(b) plan into an existing IRA after you change jobs or retire, that money is now subject to the lower asset protection limit.
However, there is a way to maintain your protection during a rollover: Roll the money from your old 401(k) or 403(b) plan to a separate rollover IRA account that doesn’t contain any IRA contributions. As long as you keep that money in a separate, traceable account, you can protect that money from creditors should financial misfortune ever befall you.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."