If you’re investing in a retirement account, you may be wondering about transfers and rollovers. When is it best to transfer investments from one account to another? Should you roll over your 401(k) into an IRA investment? How do these transactions affect your taxes? In this post, we’ll explain the differences between transfers and rollovers and how they affect your tax liability.
What is a transfer?
A transfer is when you move money from one account to another. This can be a bank-to-bank transfer or a transfer from one brokerage firm to another or even from a brokerage account to a bank account. Once the funds arrive at their destination, they’re considered “invested” because they’re not sitting in inactive savings or checking accounts anymore.
What is a rollover?
A rollover is when you move money from one retirement account to another. You can do this once a year, but not more than that. According to the professionals at SoFi, “To qualify, you must be over the age of 59 1/2 (or disabled) and not taking part in a plan such as Social Security or Medicare coverage.”
Rollovers are typically done when an individual wants to escape penalties associated with early withdrawals or otherwise alter their investment strategy without losing access to their funds.
When do you use them?
Transfers are for moving money from one investment account to another. For example, you might want to transfer your savings from a traditional IRA into a Roth IRA. Or if you have money invested in two different 401(k)s at different companies, you can use a transfer to consolidate them into one account.
Rollovers are generally used when changing jobs or retiring; they’re also useful if you’ve already cashed out your retirement savings and would like to put it back into an IRA or 401(k).
How are your investments treated for tax purposes?
In addition to the tax treatment, there is a significant difference between transfers and rollovers. If you transfer your assets from one IRA to another without first taking a distribution, that’s considered income in the year of transfer. This means that it will be taxed as ordinary income at your marginal tax rate.
Rollovers, on the other hand, are not taxable because they don’t trigger any income events like transfers do. In addition, rollovers aren’t subject to early withdrawal penalties since they’re generally done within 60 days of receiving an eligible distribution (not all distributions are eligible for rollover).
How to avoid potential tax pitfalls?
When you move money from one account to another, the IRS considers that a taxable event. For example, if you are going to make a transfer or rollover, you should consult a tax professional first.
You can avoid potential tax pitfalls by splitting up your money between multiple types of accounts. This means having some investments in an IRA, 401(k) and other retirement savings accounts while also keeping some cash on hand so that if an emergency comes up and you need access to it quickly.
While transfers and rollovers can be very useful, it’s important to understand the tax implications of each. You should also be aware that some transfers may trigger fees or taxes on your investment account.
