Understanding Your Rollover IRA

A couple working with a financial advisor in an industrial office.
••• kate_sept2004 / Getty Images

Simply stated, a Rollover IRA is an account that acts just like a regular brokerage account in all regards except that it is funded by transferring, or “rolling over”, money from a previous employer's retirement plan. It is subject to the same restrictions (for instance, you can’t make a withdrawal before the age of 59 and1/2 unless you pay your full tax rate plus a 10% penalty), but for the most part, it is far more flexible.

If you receive the proceeds of your 401(k) to invest in a Rollover IRA it is extremely important that you complete the process within 60 days. If you miss this deadline, you will be subject to substantial taxes.

The process of opening a Rollover IRA is fairly straightforward, and there are many firms from which to choose. Some brokerage firms, like Schwab, have rollover specialists who can execute your rollover to align with tax law as well as your retirement goals. Other brokerage firms, like TD Ameritrade, offer cash incentives.

What Are the Disadvantages of a Rollover IRA Compared to a 401(k)?

With a Rollover IRA, there are tens of thousands of potential investments. For those with no financial background, this can be overwhelming. It can also present the temptation to frequently trade, which can result in substantial frictional costs and sub-par returns.

Also, you can only take advantage of the Rollover IRA once each year.

What You Can Do With Your Retirement Plan Assets if You Quit or Lose Your Job

The lifetime employment our grandparents once enjoyed, sadly, no longer exists in today's competitive global economy. For the majority of the current and future workforce, the odds are good that at some point in their lives, they will leave their current employer due to company downsizing, outsourcing, termination, or in pursuit of new opportunities. It's even possible they'll quit just because they can't face the prospect of going to work anymore. 

If your employer offers a company retirement plan such as a 401(k), and you find yourself no longer employed due to reasons mentioned above, you have a few options regarding the assets you've invested throughout your employment. They are:

  • Cash out and take the money, incurring large tax penalties to the IRS. This is ordinarily a huge mistake because you also lose the tax shelter from investing in a protected account (e.g., if you made $500 in dividends from stocks held in a retirement account, you likely won’t owe any taxes on that money for decades, if ever, whereas if you held the stock in a regular non-retirement account, you would get hit with taxes each year).
  • Move the money from your current employer’s plan to your new employer’s 401(k) plan. On one hand, the transfer is relatively easy and it keeps your assets consolidated. On the other hand, you will be subject to the choices provided by your new employer. This can be a major disadvantage for investors that know which stocks they want to own, or if your new employer offers a collection of investment options that aren't quite as satisfactory as those offered by your former employer.
  • Open a Rollover IRA with a brokerage firm and have the funds from your old 401(k) deposited into the account. Not only will you continue to enjoy the tax protection of a qualified retirement account, but you will be able to invest in practically any stock, bond, mutual fund, real estate investment trust, or other security available through your broker.