Tax Advantages of a RollOver IRA

When you leave your job, retirement plan administrators will ask you what to do with the money in your account. If you have a traditional IRA or other qualified retirement account, you’ll have three choices: Keep it where it is, roll it into another qualified retirement plan such as a 401(k) or an individual Roth IRA, or take cash distributions. Each of these options comes with its own pros and cons. Let’s say you choose to roll over your old workplace plan and its corresponding account balance to one or more new plans maintained by different financial institutions. This is referred to as a “rollover” because the money is moving from one type of account (like a checking or savings account that isn’t directly connected to any sort of retirement plan) into another type of account (like a brokerage firm’s custodial IRA, Roth IRA, SEP-IRA, 401(k), etc.). Once the check has been cut and deposited in your new financial institution’s checking account — hopefully with FDIC insurance — there are several tax advantages that come along with this action.

Tax-Free Growth

If you decide to keep your money in the old retirement plan, you can expect to pay taxes on any future growth (dividends, interest, etc.) that occurs inside that plan. This is because retirement plan assets are “stashed” away from regular taxable investment accounts like the stock market. You’ll still owe taxes on the original amount you rolled into the retirement plan, but any growth from that money will be lost to taxes. If you roll over your retirement account, on the other hand, the growth will be tax-free. The reason for this is that the Internal Revenue Service treats rollovers as “transfers” of retirement assets from one account to another, rather than as “withdrawals” that force you to pay income tax on the entire amount.

No Taxes on Rollover

Rollovers from your employer’s old retirement plan to a new individual retirement account (IRA) come with no taxes. Different types of IRAs (Roth, traditional, etc.) will have different tax consequences down the line, but the initial rollover itself is a nontax event. This can be a major advantage if you like the investment options offered by the new financial institution that holds your “rolled over” money. You can ride out the growth of your retirement account without having to worry about taxes.

Tax-Free IRA Distribution

Some financial institutions will let you withdraw from your rolled over IRA as early as age 59. However, you’ll have to pay income taxes on the full amount of that distribution. If you keep your retirement money inside the plan, you can withdraw the funds at almost any time without paying taxes. You might think that the government would want its due if you withdraw the money early, but the IRS is lenient when it comes to retirement plan assets. Combined with the tax-free growth discussed above, this means that you can defer taxes until the very last minute. You can withdraw the full amount of your rolled over IRA several decades after you first contributed to the old retirement plan.

Combining Rollovers and Roth IRA’s

You can actually do both: roll over your money from your old employer’s retirement plan into a Roth IRA and then immediately make a Roth IRA conversion. This means that you’re moving money from a pre-tax retirement account into an account that is 100% taxable immediately. It’s a drastic move, but it can be extremely rewarding.

Final Words: Keep in mind

Rolling over your old retirement plan into a Roth IRA is a drastic move; it’s basically flipping a switch and converting the entire balance of your retirement account into taxable income. Make sure you understand the full ramifications of this decision before you make it. We’ve explored the tax advantages of rolling over an old retirement account, but there are several disadvantages associated with this action as well. In the next section, we’ll examine these downsides and help you decide if rolling over is right for you. If you’re re-establishing an old retirement account and want to receive the maximum possible tax advantage, you should roll over your account as soon as possible. The longer your money stays in an old employer retirement plan, the greater the chance that a change in the law will affect its tax treatment.

Conclusion

There are several reasons for rolling over an old retirement account into a new IRA. You can choose a new financial institution that offers better investment options or lower fees. You can also take advantage of the Roth IRA conversion opportunity, which allows you to convert a pre-tax retirement account into a Roth IRA and pay taxes on the amount immediately. If you’re re-establishing an old retirement account and want to receive the maximum possible tax advantage, you should roll over your account as soon as possible. The longer your money stays in an old employer retirement plan, the greater the chance that a change in the law will affect its tax