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With a rollover IRA, you transfer money from a 401(k) or other employer-sponsored account into a new individual retirement account. You can structure this account as a traditional IRA or a Roth IRA based on your preferences. A Roth IRA, on the other hand, is a type of individual retirement account. With a Roth IRA, you fund a tax-advantaged retirement account with after-tax funds. This portfolio then grows tax-free and, in retirement, you pay no taxes on your withdrawals. Here’s what you need to know.
If you need help planning your retirement, a financial advisor can help make specific recommendations for your needs and goals.
What Is a Rollover IRA?
What do you do with an employer-sponsored retirement account, like a 401(k), after you leave? This might come up because you have quit or changed jobs, and it will come up when you eventually retire.
Many employers allow you to simply keep your retirement account in place. However, this can be inconvenient for a number of different reasons. It’s hard to keep in touch with every former workplace stretching back over the course of a long career. You may want to control your own retirement account eventually, too. Some employers may not allow you to keep a portfolio with them indefinitely. Regardless of the reason, you might need to do more than simply keep a portfolio in your existing account.
This is where a rollover IRA could be a good option. It allows you to consolidate retirement savings from previous employers, potentially gain more investment options, and perhaps even lower fees when compared with employer-sponsored plans.
If you choose to roll funds over, you must follow the rules for a retirement account transfer. The easiest way to do this is with a direct rollover. This is where the old plan administrator moves assets directly from one account to the other. However, you can also transfer assets by taking them from your employer-sponsored retirement account and depositing them in your rollover IRA within 60 days. Be aware that an indirect rollover may be subject to 20% withholding taxes. This means you won’t receive the full amount to be rolled over. You’ll also need to make up that difference or deal with tax consequences.
What Is a Roth IRA?
A Roth IRA is a form of tax-advantaged retirement account. Specifically, it is known as a “post-tax” account. With a Roth IRA, you invest money on which you have already paid taxes. You receive no deduction or other current tax benefit for this capital.
The Roth IRA then grows tax-free. When you make qualified withdrawals, typically in retirement, you pay no taxes on this income. This tax-free status includes both the portfolio’s principal and its return. This has the added benefit of not increasing your overall taxable income in retirement, which lowers your taxes on all other sources of income.
This is different from a rollover IRA in that a Roth IRA refers to the portfolio’s tax status, while a rollover IRA refers to the portfolio’s funding status.
Rollover IRA vs. Roth IRA
When you open a rollover IRA, you can choose the portfolio’s tax structure. In general this means you can open your account as either a traditional IRA or a Roth IRA. Rolling funds into a pre-tax IRA generally triggers no immediate taxes. However rolling funds into a Roth IRA counts as a Roth conversion. This triggers income taxes (otherwise known as “conversion taxes”) on the entire amount rolled over.
As with all Roth conversions, the entire amount converted is also subject to the five-year rule.
You can also use an existing IRA as a rollover IRA. In this case, you would roll funds directly into the existing portfolio. There is no immediate tax difference between rolling funds into a new IRA and rolling them into an existing portfolio. However, pooling rolled over funds and IRA funds can create some issues. Most notably, it can create confusion regarding the five year rule and it can lock your money in place if you ever want to move rolled over funds back into a future employer-sponsored fund.
How an Advisor Can Help You Choose: Rollover IRA vs. Roth IRA
Advice can be useful when you are leaving a job, retiring or consolidating old retirement accounts and need to decide what to do with an existing 401(k). At that point, the choice is not only whether to move the money, but also how it should be taxed going forward. Choosing between a rollover IRA and a Roth IRA can affect taxes today, flexibility in the future and how withdrawals work in retirement.
The decision typically involves tradeoffs between current taxes and future taxes. Rolling funds into a traditional rollover IRA usually avoids immediate taxes, while moving those same funds into a Roth IRA triggers a taxable conversion. Timing, income level, and how soon you expect to use the money all play a role, and the right choice can differ depending on whether the rollover happens during high-earning years or closer to retirement.
A financial advisor can help clarify these factors by reviewing your income, tax bracket and retirement timeline. This may include estimating the tax cost of a Roth conversion, comparing how withdrawals would be taxed under each option and identifying how the account fits alongside other retirement assets. Advisors can also help explain administrative details, such as the five-year rule, required minimum distributions and how combining accounts might affect future rollover flexibility.
People considering professional guidance often ask questions such as whether paying taxes now or later makes more sense, how a conversion could affect their current tax return, or how these accounts interact with Social Security and other income sources. These decisions involve timing and tax tradeoffs that are difficult to reverse, which is why input can be helpful when choosing between a rollover IRA and a Roth IRA.
Bottom Line
A rollover IRA is a form of funding mechanism. It refers to when you move money from an employer-sponsored retirement account into an IRA of any kind. A Roth IRA is a tax status. It refers to a post-tax retirement account where you pay taxes on the capital, but pay no taxes on your withdrawals.
Retirement Planning Tips
- Managing your 401(k) in retirement is just as important as managing it up to that point. Here’s what you need to keep in mind.
- A financial advisor can help you figure out how to invest your money and then manage your portfolio for you. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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