a. you leave a company and need to rollover your 401k to an IRA
b. you need to move an IRA (or other types of retirement funds) from one financial institution to another

Do it the wrong way and you will face unnecessary IRA rollover taxes  or potential penalties.

You have sixty days to avoid the IRA Rollover tax
After you receive the funds from your IRA (if you get a physical check from the financial institution), you have sixty days to complete the rollover to another IRA account. If you do not complete the rollover process within sixty days, you will pay an IRA Rollover tax on the funds as IRS will treat them as a distribution. That means you must include the amount as income on your tax return, where any taxable amounts will be taxed at your current ordinary income tax rate. Plus, if you did not reach age 59.5 when the distribution occurred, you’ll have a 10% penalty on this distribution.

One-Year Rule or face the IRA Rollover tax
Within one year after you distribute assets from your IRA and rollover any part  of that amount, you cannot make another rollover from the same IRA to another (or the same) IRA. For example, say that you have two IRAs – IRA-A and IRA-B – and you make a tax-free rollover from IRA-A into a new IRA (IRA-C).

Within one year of the distribution from IRA-A, you cannot make another tax-free rollover from IRA-A or from IRA-C into another IRA. However, you could roll funds out of IRA-B into any other IRA because you did not roll money into or out of that account within the previous year.  So the point is that once you do a rollover, do not move the same funds again for a year or else you will have an IRA rollover tax.

The restriction on IRA-to-IRA rollovers does not apply to eligible rollover distributions from an employer plan. So you can roll over more than one distribution from the same qualified plan, 403(b) or 457(b) account within a 12 month period. This restriction also does not apply to rollovers from Traditional IRAs to Roth IRAs because these types of rollover are always taxable anyway.

Same Property Rule
Many people think that you must move cash from one IRA account to the other.  But you could move shares of stock or shares of mutual funds.  To avoid the IRA Rollover tax, your rollover from one IRA or to another IRA must consist of the same property. This means that you cannot take cash distributions from your IRA, purchase other assets with the cash, and then roll those assets over into a new (or the same) IRA. If you do, you will pay the IRA Rollover tax.

Here’s how to ALWAYS AVOID an IRA Rollover Tax
If you are simply moving your IRA from one financial institution to another, use the direct transfer method. A transfer is
1) not reported to IRS
2) has one financial institution mail or electronically transfer your IRA assets to the other institution
3) avoids the sixty day and one year rules
4) always avoids the IRA rollover tax

Therefore, when moving around funds in any type of retirement account, you can avoid an IRA Rollover tax or withholding by simply never touching the funds.  Let the financial institutions handle it.

If any of your contributions to a traditional IRA were before tax – and chances are good that they were – you’re going to owe IRA rollover tax on the full amount that you rollover to a Roth IRA.  A good place to begin when calculating how much you’ll owe is to determine how much of the distribution is considered to be nontaxable.  When you convert your traditional IRAs to a Roth IRA, the nontaxable part is the total amount of the nondeductible contributions you made to the IRAs, less the total of any nontaxable distributions you received in the past.

In general, the amount of IRA rollover tax you pay on the Roth conversion will depend mainly on your tax bracket.  Keep in mind, though, that your tax bracket can change if your taxable income increases.  If you find yourself at or near the end of a particular tax bracket before you make the conversion, be very careful about adding any additional income to your tax return. There’s a distinct possibility that the rollover funds may push you into the next higher tax bracket and the IRS will take a bigger bite out of all your income for that fiscal year.

For this reason, it’s important to check with a tax professional or the manager of your Roth account about the specifics of your situation.  You may find it more advantageous to make several limited rollovers over the course of several years, instead of performing one single rollover.  On the other hand, the tax burden may be more than offset by other advantages of having a Roth IRA.  This is where the advice of a trained financial professional is invaluable.

Regardless of how much actual tax burden you’ll have in fiscal 2010, the simple fact that you’re doing a Roth conversion in this tax year allows you to spread the IRA tax payment out over tax years 2011 and 2012, minimizing the amount you’ll pay at once.  While the exact amount of the tax burden depends on factors including the total value of the money converted and your tax bracket, spreading out the tax burden is an option you should definitely take advantage of, as it will allow you to minimize the shock of the conversion, while still reaping all the benefits that a Roth IRA affords.

By changing the rules, the IRS’s goal was that many investors would consolidate their investments and even increase the amount of savings that they put away for retirement.  There are many good reasons to include a Roth IRA in your retirement savings plan.  Speak with your financial advisor about the role they could play in your retirement portfolio as part of your comprehensive savings strategy.

For example, if you want to complete an IRA rollover from a Simple IRA to a traditional IRA, then there shouldn’t be a problem with taxes.  However, if you choose to do an indirect rollover to move your funds between accounts, you may be subjected to an IRA tax.  The reason for this is that in an indirect transfer, the funds are issued to your personally in check form, instead of being transferred directly between banks.  In order to make sure that you don’t take off with the money and not pay the taxes on it, 20% of the total funds in your account will be withheld for the IRS.

In this situation, you have 60 days from the time that the check was issued to find a new IRA account and deposit the funds into it before the remaining 20% will be released to your new account.  If you don’t make the deposit within the two month time limit, the funds will be turned over to the IRS – not released into your new IRA.  In addition to the taxes you pay on this transfer, the funds in your new traditional IRA will be taxed again when they’re taken out in retirement, leading to double taxation.

In order to avoid this IRA rollover tax situation, you’ll want to speak with your banking institution or financial advisor to ensure that they set up a direct transfer.  This means that the money will never technically be removed from a qualified IRA account, so no IRA tax will be applied to the funds.  This is usually the option that most people select in order to protect themselves from paying any unnecessary IRA taxes.

The only time that you might face a problem with taxation in a direct rollover is with the Roth IRA tax – specifically, when you’re transferring money from a traditional IRA into a Roth IRA.  In a Roth IRA, the money that’s in the account was placed there after taxes were applied, while in a traditional IRA, the money has never been taxed.  So, if you’re rolling your funds from a traditional IRA to a Roth account, a Roth IRA tax will be applied to convert the funds to after-tax monies.

Although this may seem like an unnecessary Roth IRA tax penalty, it can carry some advantages, as the money can be withdrawn tax-free later in life.  If you anticipate taxes going up in the future or suspect that you may be in a higher tax bracket upon retirement, this may be something you will want to discuss further with your financial advisor.

But what are the circumstances under which you have to pay IRA rollover taxes and how can you protect yourself from any unnecessary penalties?

First, you should know that there is no IRA rollover tax that you’re required to pay simply because you choose to rollover your money. There may be other fees involved with the transaction, but these shouldn’t be taxes owed to the IRA, provided you don’t take a distribution or withdrawal. So long as your money is directly transferred from one qualified IRA to another, you shouldn’t owe any IRA rollover taxes.

However, you should also understand that the rollover of money from one IRA to another is what the IRS designates as a reportable event.  This means that when the rollover takes place, the IRS gets notified.  Just because an event is reportable, though, does not mean that it’s taxable.

On the other hand, you should expect to have to pay IRA rollover taxes if – for any reason – the money from your IRA comes into your possession.  There are a couple of different ways this could happen.

First, you might ask for an indirect rollover, where your funds are paid to you and you have the burden of then reinvesting them into a new IRA.  Not only will you run the risk of having to pay IRA taxes in this situation, but you’ll also have a significant percentage – typically 20% – of your money withheld automatically as well.  You won’t get this money back, even if you do meet the IRS’s 60 day window for reinvesting your funds into a new IRA.

The other way this could happen is that you request a rollover of your money into an account which cannot, for one reason or another, accept the funds.  Under these circumstances, the account manager has no choice but to close your account and disburse the funds to you.  Whenever there is a distribution or withdrawal from your account, you may incur an IRA tax burden.  You might be able to minimize this burden by immediately reinvesting the money, but the key word is “minimize,” not “avoid.”

The best way to avoid IRA rollover taxes is to either leave your money where it is or, if a rollover is desirable, to make sure the rollover is managed in such a way that the money is moved directly from one IRA to another (this is known as a direct rollover).

As you might expect, any time you have questions about IRA taxes or your investments, it’s a good idea to contact a financial professional or a certified public accountant – especially when large sums of money are involved. When it comes to IRA rollover taxes, you’ll find that it’s always easier to get advice at the beginning than to try and correct a difficult or complex situation after the fact.

How is Your IRA Rollover Handled?

The most common mistake is that, through a lack of understanding of how rollovers are handled or through a communication error, the money is handled in such a way that an IRA tax burden is created.  If a rollover is properly handled as a direct rollover, no tax burden should be created. However, if the transaction is an indirect rollover or it becomes a distribution or withdrawal, IRA rollover taxes and penalties may come into play.

To see how this can happen, you should first understand why distributions and withdrawals are different from direct rollovers.  In a withdrawal or distribution, the money from your account comes into your hands.  Even if you have every intention of reinvesting your money into another IRA, once the money is placed into your hands, you have, in essence, made an IRA tax mistake.  First, the money you receive will likely be considered taxable by the IRS.  Second, any time money is sent to the account holder, the account manager had to withhold a portion of that money – usually 20 percent – to send to the IRS.  Receiving a distribution or withdrawal is probably the biggest mistake you can make in terms of IRA taxes.

Choose a Direct IRA Rollover Instead

You can avoid these IRA rollover tax mistakes by asking for a direct rollover if you’re moving your IRA funds from one account to another.  In a direct rollover, your money never comes into your hands, which – as you’ll remember from the description above – is when taxes begin to come into play.  Not only is this more advantageous for you from an IRA tax standpoint, but direct rollovers also allow you to avoid having money withheld in the first place.

If you do make a rollover mistake and end up with a distribution or withdrawal, you can still avoid some common IRA tax mistakes by reinvesting your money into a new IRA as quickly as possible.  The IRS gives you a window of time during which you can reinvest your money and defer a great deal of the taxes you would otherwise be required to pay.  That window of time is usually 60 days, which is a short period of time when you’re trying to get a new IRA established.  If you find yourself in this situation, you may want to consult a financial professional as quickly as possible to help minimize your IRA tax burden.

When it comes to paying taxes, we’d all like to pay less – and we certainly don’t want to be stuck with IRA rollover tax penalties we could have avoided in the first place.  That’s why it’s best to talk with a financial professional about all of your savings and investments before making rollover arrangements yourself.  A well qualified financial professional can help you avoid all of these common tax mistakes relating to IRA rollovers.

When you move funds from one IRA account to another, this is known as a rollover.  In essence, you’re taking the money that you’ve already set aside – tax-free – and putting it into another account that’s been set up for your retirement funds.  While it isn’t difficult to complete an IRA rollover, the related tax rules can still be confusing, depending on the way that the money is transferred.

In general, there are two different ways for you to move money between IRA accounts – direct and indirect transfers.  If you opt for a direct transfer, then the money won’t be assessed any IRA rollover taxes or penalties because it’s simply being moved from one retirement account to another without any direct interference.  The notable exception to this rule is transfers that occur from traditional IRAs to Roth IRAs, which are subject to ordinary income tax, due to their unique structures.

Alternatively, if you were to perform an indirect account, the money would be issued to you in the form of a check, and you would have 60 days to deposit it into a new IRA account.  However, this is where the IRA rollover taxes can come into play.  Since the check was issued to you and not to another bank account, a mandatory 20% fine is withheld from the total for taxation.  This is done to make sure that the money goes into another qualified retirement account – not into your pocket!

If you make the deposit within the 60 day time period specified by the IRS, then the remaining 20% will be released to your new IRA account.  If not, it will be used to settle the tax obligation generated by the cash withdrawal from your account.  To avoid these unnecessary complications with IRA tax possibilities, most people opt to go with the direct transfer.

As far as the IRA tax deduction is concerned, be aware that a rollover doesn’t count on your taxes.  Even though there’s technically a large amount of money being placed into your IRA account, it has already been written off on previous years’ taxes, so you can’t claim it again.

In addition, you can’t claim a Roth IRA tax deduction on your annual taxes for contributions rolled into these types of accounts, as the Roth accounts have been set up for monies that have already been taxed.  When you take the money out of the account later in life, you won’t have to pay taxes on it.  Therefore, be aware that you can’t claim an IRA tax deduction on this type of account as well.

If you’re moving from a traditional or Simple IRA that was provided by your employer because you’re setting out to work for yourself or own your own business, you’ll most likely want to consider an SEP IRA.  SEP IRAs have higher annual contribution limits than other types of retirement accounts and your contributions can be deducted from your annual income taxes.

On the other hand, if you’re going to start a job that doesn’t offer an IRA plan, then you can open a traditional IRA or a Roth IRA on your own.  Pre-tax contributions from your existing 401k account or traditional IRA can be rolled into a new traditional IRA with no problem, but the situation with Roth IRAs is a bit different.  The money that’s deposited into a Roth IRA has already been taxed, so there’s no separate Roth IRA tax deduction.  The good news, though, is that with a Roth account, the money won’t be taxed later on when it’s withdrawn.

Once you’ve decided on the kind of account you want to move your funds to, you’ll need to decide how you’re going to complete the rollover.  There are two different ways that the money can be moved from your existing account into the new one.  The first type is known as a direct rollover, and it simply means that the money is moved between IRA accounts directly, and therefore suffers so problems with IRA rollover taxes.

The second is known as an indirect rollover and, in this case, you’re personally issued a check for just 80% of the total.  The remaining 20% is held out for IRA taxes in case you don’t transfer the funds into a new account within 60 days.  This is typically where most of the unnecessary IRA rollover tax penalties come into play.  For example, if you take longer than 60 days to deposit the money into an account, you will have forfeited the 20% to taxes.  In addition, unless that money goes into a Roth IRA, you’ll have to pay taxes again on the income when it’s withdrawn later in retirement.  This is a common IRA rollover tax mistake that leads to double taxation.

The best thing that you can do to help avoid unnecessary IRA taxes is to go over all of the options with your financial advisor.  This way, you can decide which rollover option will yield you the best results, without any unnecessary IRA rollover taxes.

In most cases, transferring your money in a way that changes the tax status from tax deferred to taxable makes little sense.  After all, the entire reason you opened an IRA in the first place was to get out from under an immediate IRA tax burden while you built up money for your retirement years.  For this reason, there are ways to avoid the taxes on your investments that you, as the account holder, need to be aware of.

Of course, the easiest way to earn tax exemptions on your retirement money is to place it into an IRA.  These accounts, by design, will exempt you from an immediate tax burden and defer IRA taxes until you reach retirement age (with the exception of Roth IRAs).  Currently, the IRS has set the minimum retirement age at 59 ½, although you may be able to withdraw funds earlier without penalty under certain circumstances.

But when it comes to IRAs and IRA rollovers, there’s a particular financial maneuver that can open your investments up to an IRA tax burden if you aren’t careful.  While this is a perfectly legal move when it comes to rolling your funds from one account to another, it likely won’t be either the most convenient process and or the most advantageous for your retirement goals.  This maneuver is called an indirect rollover.

Here’s why.  According to the IRS, you have only 60 days to reinvest your money into a new retirement account.  Fail to get the money deposited within that set time and it will be considered a withdrawal, for which you will be subject to ordinary income taxes, early withdrawal penalties (if you’re under age 59 ½) and a mandatory withholding of 20%.  These penalties can be substantial, especially if you’re nearing retirement and have a lot of money invested in your IRA.

To protect your money from IRA taxes, you need to perform a direct rollover instead.  To do that, contact the administrator of the target IRA (the account that’s receiving your rollover) and tell him or her to perform a direct rollover.  This will begin a specific process where the money is sent straight from one IRA into the new IRA.  As the account holder, the money won’t pass through your hands, although you will still retain all the benefits of your investments when you retire.

In a direct rollover, the administrator of the target IRA will contact his or her counterpart at the other IRA to make all of the necessary transfer arrangements.  The transfer may occur in the form of a wire transfer, a check or whatever vehicle is most convenient.  However, the take home message is that the money should not come into your hands.  This is the simplest way to maintain the IRA tax exemption that’s built into the retirement investing system and protect your money as it’s moved from one account to another.

An IRA allows you to postpone paying IRA taxes on money you earn – and on the investment income that money earns – until the money is withdrawn, usually at retirement age when you’ll (hopefully) owe less in taxes.  But suppose your money isn’t just sitting in the IRA, building interest – suppose you’re actually in the process of rolling over money from an old IRA into a new account.  Will you be charged IRA taxes then?  The answer is – in most cases – no.

First, you’ll need to consider the type of account into which you’re rolling your IRA funds, as there are a few types of accounts that may not be able to accept your IRA funds.  Designated Roth IRAs and Simple IRAs, for example, can only accept rollover funds from the same type of account.  If you have a 457b IRA and try to roll your money over into a Simple IRA, the transaction will fail and the money in your account will be paid out to you.  Receiving your funds early isn’t a rollover, and will subject you to IRA rollover taxes, withholding and early withdrawal penalties.

So step one in avoiding IRA taxes during a rollover is to make sure that your new account is eligible to receive a rollover.  The second step is to make sure that not only is your new account eligible because of its structure, but also that it’s ready to receive a rollover.  Generally, there’s a delay between the time when you “open” the account and the point where it’s actually up and running (this can be a few days or a few weeks).  Fortunately, you can find the answer to this question by simply calling the account trustee or manager of the new target IRA and asking if the account is ready to receive your IRA rollover.

Once you get the go-ahead from the new account trustee, ask the trustee to initiate a direct rollover.  A direct rollover is the simplest way to avoid paying IRA taxes on your rollover, as it involves the movement of your money directly from one account to another.  Because the money is never in your physical possession, you avoid any appearance of having received a withdrawal in the eyes of the IRS.  If you request a direct rollover of your IRA funds into a new IRA account that can receive the funds and is ready to do so, you should be able to avoid any taxes on your IRA rollover account transfer.

There are two exceptions to this rule that give rise to the qualified “no” answer given above.  The first exception is the case of the Roth IRA.  If you rollover your IRA to a Roth IRA, you will be charged a Roth IRA tax penalty, unless your previous account was a Roth IRA.  This is because Roth funds are contributed after tax, so any rollovers made from pre-tax accounts (like traditional IRAs) will need to be taxed before they can be included in the account.

The second exception is in the case of the indirect rollover, a transaction that’s a kind of a hybrid between the cash out option and a direct rollover.  In this situation, your account funds are paid directly to you, and you then contribute them to a new IRA.  Because the funds are paid to you, there will be withholding, which you will only be able to get refunded if you turn around and deposit the IRA proceeds into a new IRA within the IRS’s specified time frame.  Since you do wind up contributing the funds to a new IRA, you should be able to avoid IRA taxes and penalties on the money.

A Roth IRA is an account that’s made up of after-tax contributions.  Unlike traditional IRAs, the money you contribute to a Roth has already been taxed, so you won’t need to pay additional taxes when you withdraw funds at retirement.  But because of this distinction, funds from traditional IRAs and other tax advantaged accounts can’t be moved directly into a Roth account, as this would prevent the money from ever being taxed.  Instead, the funds must be “converted” to after-tax contributions before a Roth IRA rollover can occur.

In addition, before you can perform a rollover to or from a Roth IRA, there are a few conditions that you and your accounts must meet.  For starters, you must have an adjustable gross income that’s under the IRS limits, and you must have an open and established Roth IRA.  In addition, you must move any distributions from your qualified plan into your Roth IRA within a 60 day period; otherwise, they may be subject to taxes, mandatory withholding and early withdrawal penalties (if you’re under the minimum retirement age).

However, when it comes to Roth IRA rollovers, there are a few recent changes you’ll want to familiarize yourself with.  For example, in 2009, if you wanted to rollover any funds from your 401k, traditional IRA, 403b, or other qualified plan into your Roth IRA, you could do it only if your adjustable gross income was no more than $100,000.  But starting on January 2, 2010, anyone can take advantage of the Roth IRA tax deduction – regardless of income or tax filing status.  The new rules for 2010 also eliminate the ban on conversions for married persons filing separately.

Be aware though, that even though the $100,000 income limit on a conversion expires in 2010, this doesn’t affect the income limit for making annual Roth IRA contributions, as those are two very different things.  If you earn more than the Roth IRA phase out limits, you won’t be able to make any new contributions to the Roth IRA, regardless of whether or not you’re able to initiate the conversion under the new laws.

Additionally, the 2010 law changes decrease the IRA tax burden involved in a Roth IRA rollover.  You now have the option of paying half of the IRA tax burden on the Roth IRA rollover in 2011 and the other half in 2012.  However, know that this applies only to conversions done in 2010, so you should look at this as a onetime deal.  If you’re thinking a Roth conversion might be a good move for your financial future, it is worth looking into sooner rather than later.

If you’re interested in finding out more about the 2010 tax changes as they relate to IRA rollovers and IRA taxes, you can read more at the IRS website or contact the accountant who handles your taxes for more information on how these changes affect you specifically.