Can You Convert a Rollover IRA to a Roth IRA?
Rollover IRAs offer similar flexibility as traditional IRAs: You can fund it through direct contributions or rollover funds from an employer-sponsored retirement account, and also use one to convert funds into Roth IRAs.
Withdrawals made prior to age 59.5 are subject to income tax and an early withdrawal penalty unless one of the exceptions apply.
What is a rollover IRA?
Rollover IRAs allow you to move funds from an employer-sponsored retirement plan into an individualized account. The process typically entails contacting both institutions involved, filling out paperwork for both institutions, and then submitting it.
Rollover IRAs provide tax-deferred growth and protection from creditors in bankruptcy – similar to traditional IRAs – but you must take Required Minimum Distributions by age 73.
Experts advise moving IRA funds before their due date or being subject to income taxes and an early withdrawal penalty of 10%, thus increasing your tax bill and risking increased Medicare premiums or Social Security taxes. In order to minimize penalties by keeping both plans separate – as per IRS rules one IRA rollover per year from 401(k), 403(b), 457 plans, or traditional IRAs is allowed per calendar year – experts also suggest planning carefully by stagger the conversion process over multiple years and spreading out your conversion.
How do rollover IRAs work?
There are two types of IRA rollovers: direct and indirect. With direct rollovers, funds never reach investors’ hands but instead move seamlessly from one pre-tax account to another without ever touching investors’ pockets; with indirect rollovers a check is issued directly to an investor who must deposit it within 60 days or the transaction will become taxable.
When rolling over assets, it is advisable to keep rollover dollars separate from contributions and earnings made to an IRA. Doing this helps avoid congregating assets that could fall under different protections – for example IRA assets are protected in bankruptcy while employer-sponsored retirement plan assets offer less comprehensive protections).
Rollover IRAs do not count towards annual contribution limits of $7,000 in 2024 ($8,000 for those age 50 or over). Consolidating multiple accounts may simplify recordkeeping and investment options; however, combining accounts could result in additional taxes or early withdrawal penalties during retirement withdrawals.
What are the benefits of a rollover IRA?
Rollover IRAs provide additional investment options and greater portfolio flexibility, but before proceeding with one it’s essential to carefully consider any potential tax consequences of doing so.
An indirect rollover requires income taxes to be withheld from withdrawals, potentially increasing Medicare or Social Security premiums or benefits. Furthermore, withdrawals made prior to age 59 1/2 may incur income taxes and early withdrawal penalties.
If you’re considering a rollover, speak with a Schwab advisor about your options and process. We can explain the differences between an IRA and employer-sponsored plans in terms of recordkeeping requirements, investment options and fees; our robo-advisor also allows for easy diversified portfolio building based on your goals; unlimited guidance from a CFP(tm) professional provides unlimited 1:1 guidance plus interactive planning tools – learn more about Schwab Intelligent Portfolios Premium(tm).
How do I convert my rollover IRA?
If you have an IRA from a prior employer, there may be the option for it to be converted to a Roth IRA by way of “Roth conversion.” To be safe, consult a financial advisor first before making this decision.
There are two methods for conducting a rollover: direct and indirect. With direct rollovers, your old plan or IRA sends you a check to payoff any outstanding balance; once this money has arrived in your new IRA account you deposit it directly. Indirect rollovers typically require taxes be withheld prior to deposit; you may reclaim this amount by filing a tax return and filing.
There are other differences between traditional and Roth IRAs as well. Withdrawals from traditional IRAs typically incur income tax as well as an early withdrawal penalty of 10% if taken before age 59 1/2; by contrast, withdrawals from Roth IRAs don’t incur such costs or penalties.
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