When you’re moving your money from one IRA to another IRA rollover account, you’ll want to take extra precautions to avoid making mistakes that will create an IRA tax burden for you. When handled properly, IRA rollovers can occur without any federal IRA taxes, withholding or penalties. But unfortunately, one small error can destroy this tax-free rollover status. Let’s look at how to protect your money.

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.