Rollover IRA vs. Traditional IRA: What's the Difference?

Rollover IRA vs. Traditional IRA: What’s the Difference?

Jessica has contributed to her employer-sponsored individual retirement account (IRA) plan for the last 15 years. She is making plans to quit her current job and move across the country to live closer to her family. Before starting her new job, she will travel for 3 months. Jessica will need to move her vested money from her current employer’s 401(k) plan to another retirement account. She may use a traditional IRA or a Roth IRA. IRA types can be confusing. Rollover IRA vs. traditional IRA: What’s the difference?

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What is a traditional IRA?

A traditional IRA is a tax-advantaged retirement savings account available to anyone who earns income. It is not an employer-sponsored plan. You can contribute pre-tax dollars to your traditional IRA, which reduces your taxable income for that year. Tax savings depend on your income level and whether you are participating in an employer-sponsored retirement plan. The most you can contribute to a traditional IRA in 2024 is $7,000 or $8,000 if you are 50 or older by the end of the year or your taxable compensation for that year.

The funds in your traditional IRA continue to grow tax-deferred until you make withdrawals at any time after age 59½ (early withdrawals may incur a 10% early withdrawal penalty). You must begin taking the required minimum distributions at age 73. These withdrawals are taxed as ordinary income. Since your tax bracket is lower when you are retired, your taxes on your traditional IRA withdrawals are lower than they would be if they were taxed before you deposited them into your IRA.

Stocks, bonds, mutual funds, and exchange-traded funds are all investment options with a traditional IRA. You can choose your own investment strategy or use automated technology to select investments for you.

How does a traditional IRA differ from a Roth IRA?

While you contribute pre-tax dollars to a traditional IRA, with a Roth IRA, you contribute after-tax dollars. Your investment in a Roth IRA grows tax-free. A Roth IRA does not offer any immediate tax deduction or benefit, but when you take distributions in retirement, they are tax-free.

The maximum contribution for a Roth IRA in 2024 is $7,000 if your modified adjusted gross income is below $146,000 (filing single) or below $230,000 (married filing jointly). If you are 50 or older, your maximum contribution is $1,000 higher.

You can begin taking withdrawals from your Roth IRA without paying federal taxes once you are 59½, as long as your Roth IRA has been open for at least 5 years. Unlike a traditional IRA, you are not required to take the required minimum distribution from your Roth IRA.

Contributions to a Roth IRA can come from earned income, such as a rollover from a Roth 401(k) plan, conversion from an existing traditional IRA or 401(k) plan, or a spousal contribution.

Gabriel Katzner

In 2002, Gabriel Katzner, received his Juris Doctorate with honors from the Fordham University School of Law. After spending the first 7 years of his legal career practicing at Cahill Gordon & Reindel LLP, an international law firm based in New York, he went on to found his own firm.
Building on his legal background, Gabriel’s vision emerged during his tenure at Katzner Law Group, where he excelled in estate planning, forming deep client connections. Recognizing the fleeting nature of traditional estate planning and the lack of comprehensive financial guidance, Gabriel conceived Frame Wealth Management. His commitment to lifelong client partnerships drove him to earn credentials as a CERTIFIED FINANCIAL PLANNER™ and CPWA® professional.

What is a rollover IRA?

A rollover IRA is one that contains funds that have been transferred from another tax-advantaged source. A traditional or Roth IRA can be called a rollover IRA when you roll money from an employer-sponsored 401(k) plan into an IRA. Rollover IRAs have the same benefits as a traditional or Roth IRA.

Depending on the requirements of your employer-sponsored plan, you may have the option of leaving your investments in the plan, or you may be required to move them once you leave your job. If you have multiple jobs over your lifetime, it can be hard to track these individual accounts.

If you have a Roth 401(k) from your previous employer, you can only roll it over into another Roth IRA. However, if your employer-sponsored plan is a traditional IRA, you can choose to roll it over into either a Roth or a traditional IRA.

Using a direct rollover, your current plan directly transfers your rollover to your new IRA provider, and no taxes are withheld. With an indirect rollover, your current provider sends you a check for your funds, and you deposit them into your IRA. You have 60 days to deposit the full amount into your IRA. If you do not deposit the money, it is subject to federal income tax, and it may incur an early withdrawal penalty.

You can avoid taxes if you transfer money from a tax-deferred account to a traditional IRA. However, if you do a rollover from a pre-tax 401(k) to a Roth IRA, you will be charged ordinary income tax on the entire transfer amount because Roth IRAs are funded with post-tax dollars. This is called a Roth conversion.

Choosing an IRA

Roth and traditional IRAs refer to the tax status of the funds in the accounts. A rollover IRA refers to the source of the funds in an account.

If you need help choosing the best IRA options for a new or rollover IRA, consult with a certified financial professional. They can help you look at all your options and evaluate the advantages and drawbacks of each option.

Financial advisors are typically paid under a fee-only, commission-based, salary-based, or combination business model. Fee-only financial planning involves charging based on an hourly or annual fee, a fixed annual retainer, or a percentage of your assets. Fee-only financial planning can be ideal when you are making IRA decisions because the goals and interests of the financial advisor and client are aligned.

There is no one-size-fits-all guide to investment. Working with a wealth manager can ensure you make the best financial decisions for yourself and your loved ones.

Frame Wealth Management, Gabriel Katzner

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