There may come a time when you decide to rollover an IRA. When you’re in this situation, you need to understand the benefits of a direct transfer (direct rollover) versus a 60-day rollover (indirect rollover). Because this directly impacts your retirement income, I want to help you understand your options.
A direct transfer and a direct rollover are basically the same. The only difference is that the tax code uses “direct transfer” for IRAs and “direct rollovers” for discussing qualified plans. Regardless of the type of account, a direct transfer distributes funds to a tax-deferred account, not to you. There are two ways to go about a direct transfer for both IRAs and qualified plans:
- ACH/Wire Transfer: Funds are wired directly to another qualified account. Because you never touch the funds, this is the preferred method.
- Check Payment: Distributed funds arrive in the form of a check. The check is payable to the custodian who holds your funds (such as Fidelity, Schwab, Bank, etc.)
Indirect Transfer (60-day Rollover)
The indirect transfer and a 60-day rollover are basically the same. You receive distributed funds and redeposit them into an IRA or qualified retirement plan within 60 days. (You may also rollover only part of the money). In situations where you roll funds into an IRA within sixty days of receipt, there are two things you should keep in mind:
- To avoid tax liability, you must re-deposit 100% of your distribution, including the 20% that was withheld. Any difference between the amout you receive and the amount you deposit is taxable.
- With only a few exceptions, you may do one rollover, during any 12 month period.
Benefits of a Direct Transfer
If your goal is to continue tax deferral, Maestro Wealth recommends the direct transfer. Benefits include:
- Simplicity: You really can’t get much simpler than a direct transfer one with a check or ACH/wire transfer. With an ACH/wire transfer, you never even touch the funds. That’s one less thing to worry about!
- Once-per-Year Rollover Rule: Direct transfers are exempt from this rule. That means you can do an unlimited number of direct rollovers in a 12 month period without violating this often overlooked restriction.
- Withholding (qualified plans): Direct transfers are not subject to any withholding rules. However, qualified plan rules mean 20% of distribution paid to you directly is withheld. The Federal government receives that 20% to cover any potential tax liability.
- Inherited IRAs: A direct transfer is the only way an Inherited IRA owner can transfer an Inherited IRA account to another institution. Amounts from the Inherited IRA made payable to the beneficiary is income. Moreover, unless we are talking about an error committed by the custodian, there is no way to “fix” this mistake.
- Divorce: If IRA assets are awarded in a divorce through a QDRO (Qualified Domestic Relations Order), a direct transfer is the only way to do a non-taxable distribution of the amounts awarded to the ex-spouse.
- Timing: Unlike 60-day rollovers, direct rollovers are not subject to time constraints.
- IRS Relief: Unlike 60-day rollover issues, any problem that occurs with a direct rollover will automatically qualify for tax relief.
As you can see, if you’re moving funds between IRAs or qualified plans and want to defer taxes, a direct transfer is the way to go.