Individual retirement accounts, or IRAs, are a cornerstone of many retirement savings plans. When people save for retirement with an Individual Retirement Account (IRA), they do it in a tax-advantaged manner. The need to transfer assets from one retirement plan to another might prompt either the opening of a traditional IRA or the conversion of an existing 401(k) or other retirement plans into a rollover IRA. There are a lot of parallels between rollover IRA vs. traditional IRA, but there are also some important distinctions.
List of Contents
- What Is a Traditional IRA?
- What Is a Rollover IRA?
- An In-Depth Analysis of Rollover IRA vs. Traditional IRA
- Is There a Difference Between Rollover IRA vs. Traditional IRA
- How to Open a Traditional or Rollover IRA Account
- FAQs about Rollover IRA vs. Traditional IRA
What Is a Traditional IRA?
Unlike 401(k) plans offered by employers, traditional IRAs are set up independently and provide tax benefits in retirement. When funds are transferred to a traditional IRA from another account, the account is dubbed a rollover IRA. However, some traditional IRAs are not rollover IRAs because they have been self-funded.
You can deduct your contributions to a Traditional IRA from your taxes if you meet the requirements set forth by the IRS. Generally speaking, you cannot deduct donations on your tax return if your adjusted gross income is more than $76,000 as a single tax or $125,000 as a married couple. If a workplace retirement plan protects you, your annual contribution can only be up to $6,000.
Although ‘tax-deductible’ contributions are the norm for regular IRAs, it is possible to open one supported entirely by “non-deductible” funds. This is because you either earned too much money to qualify for an instant tax advantage or started the IRA with money you already had before taxes were taken out.
What Is a Rollover IRA?
A rollover IRA is an Individual Retirement Account (IRA) into which funds have been moved from another qualified retirement plan (such as a 401(k) or 403(b)) in order to take advantage of tax benefits available to IRAs (b). One type of IRA that can “roll in” funds is the classic IRA.
At least a remote possibility that you will desire to keep the retirement benefits from a job you’ve left. Consider transferring your 401(k) funds to a standard IRA, creating a hybrid “rollover” IRA.
Remember that a rollover IRA is funded with money from another qualified retirement plan. You are free to form your own traditional IRA and begin investing it with money from your bank account, but this type of account is not a rollover IRA.
An In-Depth Analysis of Rollover IRA vs. Traditional IRA
| Rollover IRA | Traditional IRA | |
| Supporting Factors | “Rolled over” funds come from a preexisting retirement account, such as a 401(k) or 403(b), and are deposited into the new account (b). There are no annual contribution caps on the amount that can be rolled over. | Produced by making annual deposits not exceeding the annual contribution limit, rolled-over funds may also be deposited into a standard IRA. |
| Limits on contributions | You can transfer as much money as possible from another account into this one. The annual cap for contributions other than a rollover is $6,000, with an additional $1,000 allowed if you are 50 or older. | You can make up to $6,000 annually, with an extra $1,000 if you’re 50 or older. |
| Guidelines for Withdrawal | With some exceptions, such as for qualified higher education costs or a first home purchase, withdrawals made before age 5912 are subject to income taxes and an early withdrawal penalty. | With few exceptions, such as for qualified higher education costs or a first-time homebuyer’s tax credit, withdrawals before age 5912 are subject to income taxes and an early withdrawal penalty. |
| Required minimum distributions (RMDs) | Once you reach the age of 72, you must begin taking annual withdrawals from this account. | Once you reach the age of 72, you must begin taking annual withdrawals from this account. |
| Taxes | Because the funds have already been taxed when contributed, withdrawals after retirement will be subject to ordinary income tax rates. | All retirement withdrawals from a tax-deductible IRA will be subject to ordinary income tax rates. In retirement, you will only be taxed on the earnings (unless you made non-deductible contributions). |
| Future rollover options | If the retirement plan at your next workplace supports rollovers, you can take this money with you when you leave. | You can’t take your traditional IRA funds and put them into your new company’s 401(k) plan. |
| Convertible to a Roth IRA | Yes | Yes |
Is There a Difference Between Rollover IRA vs. Traditional IRA
If your company’s retirement plan accepts rollovers, you can use the money you rolled into a rollover IRA toward your retirement there. In contrast, this is not the case with funds in a typical Individual Retirement Account.
The only significant distinction between a rollover IRA and a standard IRA is that the funds in the former were transferred from a previous employer’s retirement plan. Tax treatment of withdrawals, RMDs, and Roth IRA conversions is the same for both types of accounts.
How to Open a Traditional or Rollover IRA Account
The sole distinction between a regular IRA and a rollover IRA is how the account is initially funded. If you want to start an IRA, either a traditional or a rollover, you can do so by:
Consider the options for opening your IRA and make a decision
If you want to pick your investments, you can open an account with an online brokerage, while a Robo-advisor will make suggestions based on your responses to a few simple questions. (Robo-advisors usually have a nominal cost.)
Open a bank account
Opening an IRA with a particular provider includes selecting the desired IRA type (traditional or rollover) and entering primary identifying data. Provide your SSN, date of birth, and other identifying details, as well as your current and previous addresses, phone numbers, and places of employment.
Fund the account
You can put money into the account in a few different ways: by writing a check, transferring funds from another IRA, or rolling over funds from a workplace retirement plan. Get in touch with your company’s plan administrator to learn more about the latter option.
FAQs about Rollover IRA vs. Traditional IRA
Can You Contribute to a Rollover IRA?
Depending on your income and eligibility, you may be able to contribute to your rollover IRA. You can put in as much as $6,000 in 2021 and 2022 (or an extra $1,000 if you’re 50 or older) as an individual. However, if you fund your rollover IRA with additional funds, you may lose the option to transfer the funds to a different retirement plan in the future.
Can You Combine a Traditional IRA with a Rollover IRA?
Simply put, a rollover IRA is a standard IRA into which funds have been transferred. One way to merge IRAs is to roll over funds from one IRA into another or to make a direct transfer from one IRA to the other.
Timeliness of any transfers or rollovers is crucial to avoid having the funds be considered an early withdrawal or distribution. Fund assets transferred via indirect rollover must be deposited into the receiving fund within 60 calendar days of the closed fund’s closure.
Remember that you can lose the option to roll over cash into a retirement plan with a future employer if you contribute money to a rollover account that is not eligible for rollover. In addition, remember that you can only do one rollover between IRAs per calendar year. Unlike rollovers from other retirement plans to an IRA, this limit only applies to transfers between IRAs.
There is not much difference between a rollover IRA and a standard IRA in terms of the tax benefits they provide for retirement savings.
Will you continue making payments into the rollover IRA after the initial transfer? is a crucial question to ask yourself. If so, you won’t be able to convert the rollover IRA into a 401(k) or other workplace retirement plan in the future.
Whether you have a standard IRA that you’ve opened with regular contributions or a rollover IRA that you’ve established by transferring funds from your employer’s retirement plan, both can be valuable components of a comprehensive retirement savings strategy.
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Source: Capitalize, SoFi