With so many different types of retirement accounts available, it is often not readily apparent which types of rollovers are permissible. Even though an IRA rollover is simply a transfer of funds, the Internal Revenue Code is specific as to which account transfers receive preferential tax treatment.
The IRS publishes a concise chart that summarizes the various types of rollovers permitted by the tax code. Participants in most types of retirement plans can roll over some or all of their funds into a traditional IRA or a Roth IRA to help achieve their financial planning objectives.
Traditional IRA to Roth IRA
The most common type of rollover is probably the conversion of a traditional IRA to a Roth IRA. Even though your income contributed to a traditional IRA is tax-deferred, many account owners decide to switch to a Roth IRA for greater long-term benefits. After paying income tax on the traditional IRA withdrawal, the new Roth IRA begins earning tax-free interest. When the Roth IRA is eventually distributed, you receive all funds tax-free.
401(k) plan to IRA
Many workers prefer to move their 401(k) funds from an employer-sponsored plan after leaving for other work. Employer-sponsored 401(k) plans are also referred to as qualified plans. You are allowed to move your 401(k) funds to a traditional IRA and retain the tax-deferred status. Alternatively, you may transfer the 401(k) funds into a Roth IRA after paying tax on the 401(k) distribution.
Governmental plan to IRA
Different sections of the tax code apply to governmental employees. Instead of a 401(k) plan, governmental workers are likely to participate in a 457(b) plan or a 403(b) plan. The tax treatment of a rollover from a governmental plan is similar to a rollover from a 401(k) plan. The taxability of the plan distribution depends on whether your new account is a traditional IRA or a Roth IRA.
Designated Roth plan to IRA
Some employer-sponsored retirement plans allow workers to fund their accounts on an after-tax basis, rather than a pre-tax basis. The employer plans are referred to as designated Roth accounts because of the after-tax treatment. A designated Roth account balance can be moved to a regular Roth IRA, but not to a traditional IRA.
A traditional IRA can be rolled over to another traditional IRA. A Roth IRA can be rolled over to another Roth IRA, but not to a traditional IRA. Contact a financial planning specialist for more information about using an IRA rollover to meet your investment objectives.