What’s a rollover IRA?

Whenever you leave a job—whether you’re retiring or not—you have to decide what to do with your retirement account. You generally have four options: Move it to your new employer’s plan, leave it where it is, cash it out, or transfer it to a rollover individual retirement account (IRA). A rollover IRA is one type of account that lets you withdraw from your employer-sponsored retirement plan without being taxed or penalized, so you can continue to save for retirement.

What’s the difference between a traditional and a rollover IRA? 

Let’s start by defining a traditional IRA—which is a personal retirement account that you can open with a financial institution in order to invest your retirement savings. The money you put into an IRA may be tax deductible, depending on your income and your filing status, and the earnings on that money aren’t taxed until you take it out. If you take money out before you turn age 59½, you’ll owe a 10% IRS penalty for early withdrawals, in addition to the taxes on your earnings.

A rollover IRA account functions much the same way as a traditional IRA, but you can’t just walk into your bank and open one. The money must come from another qualified retirement plan—such as a 401(k), 401(a), or 403(b). 

Why would you want a rollover IRA? Because, generally, when you leave an employer, you have to decide what to do with your retirement savings—you can cash it out or keep saving. While it may be tempting to take the cash, this decision can be costly, as you’ll owe taxes and penalties. The other three options allow you to keep saving and avoid these penalties. We’re going to focus on why you might choose a rollover IRA.  

What are the benefits of opening a rollover IRA? 

If you want to avoid penalties and keep saving for retirement, you can: 

  • Leave your savings in the current plan,
  • Move it to a new employer’s plan, or
  • Transfer it to a rollover IRA.

Rollover IRAs offer you the freedom of choice and flexibility. You can choose the financial institution, and you’re no longer bound by the investments offered by your employer’s retirement plan. Most IRA rollover accounts allow you to make additional contributions—beyond the initial rollover amount—without having to open a separate IRA account. And unlike employer-sponsored plans, they’re not dependent on where you work. In fact, you may have multiple retirement accounts from previous employers. If that’s the case, you can combine them all into one rollover IRA to make them easier to manage. 

When you’re deciding if a rollover IRA is right for you, you should also be aware of the benefits of keeping your money in an employer-sponsored retirement plan. Workplace retirement plans may allow loans, while IRAs don’t. And while an employer-sponsored plan may shield your money from potential bankruptcy in some states, IRAs don’t offer this protection. 

Can you take money out of a rollover IRA?

Generally, you’ll owe taxes and penalties if you take money out of an IRA or employer-sponsored retirement plan before age 59½. IRAs, however, allow you to access your savings before retirement, if you plan to use it for certain purposes. 

Early withdrawals from different types of retirement accounts

 

Rollover IRA 

Employer-sponsored plan

What you’ll owe

  • 10% early withdrawal penalty before age 59½
  • Taxes on earnings
  • Taxes on any pretax contributions
  • 10% early withdrawal penalty before age 59½
  • Taxes on earnings
  • Taxes on pretax contributions

Exceptions

  • Educational expenses
  • First-time purchase of a primary residence
  • Unreimbursed medical expenses

Some plans allow hardship withdrawals, which must meet a strict set of criteria.

Before you take a withdrawal, it’s best to consult your tax or other financial professional to be sure you understand the financial impact of withdrawing money from your IRA.

What investments are available in a rollover IRA? 

The investments offered in a rollover IRA depend on the financial institution you choose. Generally, you’ll be able to invest in certificates of deposit (CDs), mutual funds, and exchange-traded funds (ETFs). You may also have access to a personal brokerage account—in which you can invest in individual stocks. Make sure you research the financial institution, investment offerings, and fees before you decide where to open your rollover IRA.

When should you choose a rollover IRA? 

There are important things to consider before you decide to open a rollover IRA. In addition to reviewing the investment choices available and your ability to access your money, you’ll want to compare the account fees for your workplace plan and a rollover IRA. You may find it helpful to consult with a tax or other financial professional to help you make these decisions. The important thing is to find the option that’s right for you and your hard-earned retirement savings. 

As other options may be available, you are encouraged to review whether taking a cash distribution, staying in a retirement plan, rolling over into an IRA or another option is best as there are advantages and disadvantages to each.

The content of this document is for general information only and is believed to be accurate and reliable as of the posting date but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made herein.

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