Rollover and traditional IRAs are Individual Retirement Accounts, or long-term savings accounts on which the Internal Revenue Service, IRS, bestows various tax advantages. Since 2002, the differences between the two types of accounts have greatly diminished, to the point where the only real remaining difference is in the source of funding for each type of account.
Source of Funding
Rollover IRAs are funded with contributions from previously funded qualified plans, such as 401k plans. Traditional IRAs are funded with investor contributions.
Contribution Limitations
Although you can make an annual contribution to a rollover IRA, once you do so, the account must be reclassified as a traditional IRA. Contributions to traditional IRAs are limited by the IRS to an annually-updated amount as published in IRS Publication 590. For 2010, your traditional IRA contribution limit is the lesser of $5,000 or the amount of your taxable compensation. If you are age 50 or older, you are permitted a $1,000 "catch-up" contribution, bringing your total contribution limit to $6,000. There are no contribution limits on rollover IRA contributions.
Deductibility of Contributions
One of the main benefits of a traditional IRA is the deductibility of your contributions. If your IRA is your only retirement plan, you can deduct the full amount of your annual contribution. However, if you are covered by another retirement plan at work, you must consult the deductibility matrix in IRS Publication 590 to determine whether or not your contribution can be deducted. The deductibility of your contribution is a factor of your modified adjusted gross income and your tax filing status. Rollover IRA contributions are never tax-deductible, as you already received a tax deduction when you contributed the funds to your qualified plan account.
Portability
Before 2002, only rollover IRA assets and not traditional IRA assets could be moved into a qualified plan. Thus, most investors kept their rollover and traditional IRA accounts segregated to preserve the portability benefits of the rollover IRA. However, the 2010 IRS rollover chart shows that funds from traditional IRAs can now be rolled over into qualified plan accounts as well, so there is no longer a benefit to keeping rollover and traditional IRA funds segregated for portability purposes.
Taxation
Contributions and earnings grow tax-deferred in traditional and rollover IRAs. For both types of accounts, all distributions are taxable at ordinary income tax rates.
Required Distributions
The IRS requires that you begin taking distributions from rollover and traditional IRAs once you reach age 70 1/2. The specific amount is determined by dividing your life expectancy, as found in IRS tables, into your year-end account value.
Penalties
Withdrawals from both rollover and traditional IRAs before you reach age 59 1/2 are subject to a 10 percent early withdrawal penalty. Failure to take your required minimum distributions upon reaching age 70 1/2 results in a 50 percent penalty tax on the amount you did not withdraw.
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