Rollover IRA vs. Roth IRA (2024)

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 make specific recommendations for your needs and goals.

What Is a Rollover IRA?

When you have an employer-sponsored retirement account, like a 401(k), one of the biggest questions is: What to do with this portfolio 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, but this can be inconvenient for a number of different reasons. If nothing else, you may not want 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, and some employers may not allow you to keep a portfolio with them indefinitely. Regardless of the reason, you might need to do something with this portfolio other than simply keep it in your existing account.

This is where a rollover IRA could be a good option, as 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, where you have the old plan administrator move 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, meaning you won’t receive the full amount to be rolled over and will 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.

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.

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