Make Your Money Work Harder: Direct IRA Transfers Demystified

Everything You Need to Know About How Direct Transfers Work

If you’re considering transferring your retirement account (IRA) balance from one provider to another, you can initiate a “trustee-to-trustee” transfer by contacting your current provider. This method allows for a seamless transfer of funds directly from one financial institution to another without incurring taxes. It’s important to adhere to specific guidelines for a smooth process.

To guide you through the direct IRA transfer process and ensure that your savings are relocated correctly, it’s advisable to consult with an investment advisor portfolio manager. They can thoroughly assess your unique financial situation and provide tailored advice for a successful transfer.

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Transferring an IRA to an IRA

Facilitating an IRA-to-IRA transfer is a straightforward process, particularly when dealing with the same type of account. Suppose you initially opened a traditional IRA with one financial institution but have identified a more favorable option with another institution, whether due to lower fees or superior fund offerings.

Start by gathering important details from your current account, like passwords, account numbers, statements, and any related documents. Also, make sure to collect key information from the other financial institutions, like their main address. You’ll need all this info when you reach out to your bank to transfer money directly to another account. Doing it this way ensures a smooth electronic transfer without directly handling the money, which helps avoid any possible tax issues.

If you don’t do a direct transfer properly, the bank might send you a check for your current account balance and this could lead to tax issues. To steer clear of taxes and penalties ( if you’re under 59.5 years old), you need to deposit the check into another IRA account within 60 days of getting it. If you miss this deadline, the IRS treats the money you received as a distribution, and that will likely have tax consequences.

Converting an IRA to a ROTH IRA

When people transfer their IRAs, they often switch to a Roth IRA. If you’re staying with the same bank, just reach out to them and ask for a conversion. But here’s the catch: the transferred amount will be counted as income, and you’ll need to pay taxes on it. So, be prepared for that tax bill when you make the switch.

By the way, there is an assumption that you funded your traditional IRA entirely with pre-tax money, but it is possible you funded your traditional IRA with money that was already taxed (after-tax contributions), which is called a non-deductible IRA. When you convert this to a Roth IRA, you might not owe taxes, especially if there haven’t been any gains. If there are gains, you’d owe taxes only on the gains and on the part of your balance funded with pre-tax money. But this whole process, called a backdoor Roth IRA conversion, can get a bit tricky. It’s a good idea to chat with an investment advisor portfolio manager who knows their stuff before diving into it. They can help you navigate the complexities.

If the tax from converting your IRA to a Roth IRA seems like a lot to handle at once, you have another option. You can do it bit by bit, moving parts of your IRA balance into a Roth IRA each year. Just keep in mind, the Tax Cuts and Jobs Act (TCJA) brought down tax rates for many people, but these lower rates are set to expire in 2025 or maybe even earlier if there’s political action to change them. So, it might be a good idea to convert as much as you can each year before the rates potentially go up again.

The rules for IRA conversion got a shake-up during the Trump Administration. Before, if you earned more than $100,000, you couldn’t switch from a traditional IRA to a Roth IRA. But the new tax law got rid of this limit. However, keep in mind that laws can change, and Congress might decide to tweak this again. So, if you’re eligible under the current rules, it’s a good idea to make the move while you still can.

A Direct Rollover from a 401(k) to an IRA

There’s another type of IRA transfer, technically known as a rollover, where you shift your 401(k) balance into an IRA. This often happens when you switch jobs. To do this, get in touch with your 401(k) plan administrator and ask for a direct rollover from your 401(k) to an IRA you pick. Using this precise language helps you sidestep the tax issues we talked about earlier.

As we discussed earlier, in the retirement plan area, it’s crucial to note that “rollovers” and “transfers” mean different things. According to the IRS, a rollover generally refers to shifting funds from a qualified plan that’s not an IRA, like a 401(k), directly into an IRA. The main difference is in the paperwork — you need to report this move to the IRS when it’s a rollover.

Additionally, there’s the option of an indirect rollover. Here, your 401(k) plan provider sends you a check for your balance. The catch is that you need to deposit it into an IRA within 60 days, or you might encounter tax consequences. The IRS allows you to do indirect rollovers once every 12 months. So, it’s a time-sensitive process.

Exception

There’s a special case in IRS regulations: if your account has less than $1,000, your employer may close it and send you a check for the total balance with income taxes already deducted. The good news is, that if you deposit this money into another qualified retirement account within 60 days, the IRS won’t hit you with an early withdrawal penalty. But be cautious — if you don’t make that deposit, the government will tax the money fully, treating it as income and an early withdrawal if you’re under 59 and a half.

In Conclusion…

The easiest way to move your money between IRAs is through a trustee-to-trustee transfer, also known as a direct transfer. The financial institutions handle the transfer directly. Whether you want to move funds from one IRA to another IRA, or from an IRA to a Roth IRA, you can request a direct transfer.

If you’re moving money from a 401(k) to an IRA, you’ll want to ask for a direct rollover. Once again, the providers take care of moving the money directly between them. The benefit of using these methods is that you avoid triggering taxes.

However, before making significant moves or tackling complex retirement decisions, it’s a good idea to consult an investment advisor portfolio manager for guidance. They can provide personalized advice based on your specific situation.

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Joe A. Macek, FMA, CIM, DMS, FCSI

Investment Advisor, Portfolio Manager

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