What Is a Non Conduit IRA?

The universe of IRAs includes traditional, Roth, SEP and SIMPLE accounts. They are all non-conduit, but you can make your traditional IRA a conduit account by carefully controlling rollovers, contributions and distributions.

A conduit IRA is an account that you can use to temporarily park assets from a qualified retirement plan, such as a 401(k), until you roll the assets into another qualified plan. To qualify, a conduit IRA can only accept rollovers from a qualified plan. You cannot roll over any other assets into a conduit IRA, make contributions or take distributions. You don’t need to use a conduit IRA to roll over money to a qualified plan, but using a non-conduit IRA will not preserve certain tax advantages when you subsequently roll over the IRA assets to another qualified plan.

A conduit IRA offers these advantages:

1. Net unrealized appreciation (NUA): NUA is the value of a security in excess of its cost basis, that is, what you paid for it. If you have a qualified plan that contains stocks or bonds issued by your employer, you are entitled to a tax break on the NUA in the employer securities when you receive them in a lump-sum distribution from your qualified plan. Under the proper circumstances, you can postpone paying taxes on the NUA of employer securities that you withdraw from your qualified plan. You don’t pay the NUA until you sell the securities, and the NUA will be taxed at the lower, long-term capital gains rate as opposed to your marginal tax rate for ordinary income. You preserve this tax break if you perform a qualified rollover of these securities to a conduit IRA and then roll over the IRA to another qualified plan. In this context, a qualified rollover is a lump-sum distribution of your entire qualified employer plan due to certain reasons, including separation from your job or reaching age 59 1/2.
   
2. Capital gain treatment: If you were born before January 2, 1936, your qualified plan allows you to have a portion of a lump-sum distribution be taxed at the 20 percent long-term capital gains rate rather than your marginal tax rate. The lump-sum portion eligible for this treatment is the ratio of the months you actively participated in the plan before 1974 divided by total months of active participation.
   
3. 10-year tax option: If you were born before January 2, 1936, you can take a lump sum distribution from your qualified plan that is taxed at a rate equal to your average tax rate over the previous 10 years. You pay all the tax when filing for the distribution year – the tax is not spread out over multiple years. This option can be useful if your tax rates were lower in previous years than it is in the year of the lump-sum distribution.
   

You must roll the shares from the conduit IRA back to a qualified plan to obtain these benefits, as they are not available from an IRA. The only role of the conduit IRA is to preserve the benefits should you roll it over to a qualified plan.

If you maintain a conduit IRA, you will also need a non-conduit one for contributions and distributions as well as rollovers from sources other than qualified plans. Unless you need the special benefits preserved by a conduit IRA, there is no reason to bother with one. Using a non-conduit IRA alone is more convenient because you only deal with one set of tax forms each year from your IRA custodian. You also save any fees required to set up and maintain a conduit IRA. Finally, you can set up a non-conduit IRA as a Roth account, something you can’t do with a conduit IRA.