Rollover IRA

• A rollover IRA is established by accepting funds from some other retirement plan, such as a 401k, 403b or another IRA. The IRA is designated as a rollover only in the sense that it receives a large amount of money from the other plan and must properly account for it rather than get an IRS penalty for excessive contributions. This rollover is performed through custodian recording requirements. Money comes out of one plan, and a 1099-R is sent. Money goes into the rollover IRA, and a Form 5498 is sent that should match the amount taken out on the 1099-R. When the rollover is done properly, it is a tax-free move.
  
  

Traditional Versus Roth

• Many employer plans offer traditional types of retirement plans in which employee contributions are deducted from income. Traditional retirement plans grow deferred and add distributions to income. Roth structures provide no deduction against income, grow deferred and add nothing to income when distributed. A rollover IRA owner with a traditional IRA can convert the funds into a Roth to get tax-free growth.
  
  

Conversion Limits

• As of 2010, there are no income limits for converting traditional IRA assets into Roth assets; income limits still exist for Roth IRA contributions. There is one imposition that does restrict some rollover IRA owners from converting: the funds to pay the taxes. When you convert in 2011, you must add everything from the rollover IRA to your annual income when filing taxes in 2012. Conversions in 2010 allowed the value split among 2011 and 2012 making it easier. Paying the taxes from the IRA funds results in a distribution and early distribution penalties. It also erodes the amount growing tax-free in the Roth.
  
  

Other IRS Considerations

• The IRS allows you to perform one rollover per 12-month period. If you have a rollover IRA and later convert it, the conversion is considered a rollover but is exempt from the one-year rule. Once you convert the IRA, you must hold it for at least five years to obtain tax-free income. This rule is in addition to the rule that you must be at least age 59 1/2 to take qualified distributions without penalty. Regardless of age, if you take funds out before the five years elapse, earnings are added to income and penalized 10 percent.