What is a “rollover IRA”? Generally, the term refers to an IRA that you establish to receive funds from an employer retirement plan like a 401(k).
Oftentimes, when you move funds over from an employer plan to an IRA, your financial institution may suggest that you use a rollover IRA to receive the funds. There are at least two reasons to consider keeping your employer plan rollover separate from your contributory IRAs.
The first reason to maintain a separate rollover IRA deals with federal bankruptcy law. Your IRAs are protected from your creditors under federal law if you declare bankruptcy, but this protection is currently limited to $1.28 million for all your IRAs.1 The $1.28 million limit doesn't apply, though, to amounts you roll over to an IRA from an employer plan, or any earnings on that rollover. These dollars are protected in full if you declare bankruptcy, just as they would have been in your employer's plan. Obviously, it's easier to track the amount rolled over, and any future earnings, if you keep those dollars separate from your contributory IRAs. So a rollover IRA may make sense if creditor protection is important to you.
The second reason to maintain a rollover IRA is that you might decide in the future that you want to roll your distribution back into a new employer's plan. These days – though not always in the past – employer plans can accept rollovers from both contributory IRAs and rollover IRAs.2 Despite this, employer plans aren't required to accept rollovers, and they can limit the types of contributions they'll accept. And while it's becoming less common, some still accept rollovers only from rollover IRAs. So keep this in mind if you are contemplating a rollover back to an employer plan in the future.
Please note, a rollover of retirement plan assets to an IRA is not your only option. You should carefully consider all of your available options which can include but not be limited to keeping your assets in your former employer's plan, rolling over assets to a new employer's plan, or taking a cash distribution (taxes and possible withdrawal penalties may apply). Prior to a decision, be sure to understand the benefits and limitations of your available options and consider factors such as differences in expenses, plan or account fees, available investment options, distribution options, possible legal and creditor protections, the availability of loan provisions, tax treatment, and other concerns specific to your individual circumstances.
1SEP and SIMPLE IRAs have unlimited protection under federal bankruptcy law.
2Nontaxable traditional IRA dollars can't be rolled back into an employer plan.
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