How Much Can You Contribute to Your Ira
What Is a Rollover IRA?
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Retirement is a glorious time in life that most people look forward to with excitement, but it takes some advance preparation if you want to really enjoy those golden years of leisure. Although you may be ready to kick back and kick your job to the curb, it won't be possible if you don't set aside the money to cover your ongoing living and recreation expenses before you officially retire.
Many people choose to set up IRAs (individual retirement accounts) during the years they work (the earlier the better) to ensure the funds they need will be ready and waiting when they retire. IRAs come in several forms with different rules, so it's important to understand the details of the retirement account you open. Traditional IRAs and Roth IRAs are the most popular options, with the key difference being when you pay taxes on the saved income. In some cases, people open Rollover IRA accounts, but what does that mean exactly? Let's take a look!
Traditional IRA vs. Roth IRA
Traditional IRAs and Roth IRAs aren't the only options for IRAs, but they are the two most common choices. The difference between them is relatively simple, but choosing poorly could cost you a lot of money in taxes. Both types have a connection to Rollover IRAs and both allow you to deposit up to a specified amount each year — $6,000 in 2020. If you're over the age of 50, you qualify to deposit another $1,000 per year.
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For a Traditional IRA, you make your deposits without paying taxes on the money up front. Instead, you pay taxes as you withdraw the money throughout your retirement. Most employers use a similar structure and deduct retirement plan contributions before calculating tax deductions from paychecks. In contrast, a Roth IRA requires you to pay taxes on the money up front along with the rest of your payroll taxes. When you withdraw the money after retiring, the taxes are already paid, and you won't have to pay anything to the IRS as long as you don't incur any penalties.
Why does it matter which type you choose? Well, it really depends on the income you make as you work versus the income you expect to make in retirement. When you retire, your job income will stop, but if you prepared well for your post-working days, you could have very profitable resources — rental real estate holdings, for example — lined up to support you. You could also inherit a business or other assets that provide income after your retirement.
You probably won't know everything about your future income, but it's important to come up with a good estimate. If you think your income will increase after retirement, you want to open a Roth IRA and pay taxes on your contributions as soon as you make the money when you are in a lower tax bracket. If you expect to make less in retirement (more common), you want to open a Traditional IRA to take advantage of paying taxes based on your future lower tax bracket when the withdrawals are made.
General Purpose of a Rollover IRA
If you already have a 401(k) or other type of retirement plan established through your employer, you can "roll" the funds in that retirement account into a Traditional IRA by following the correct procedures. The main purpose of the transfer is to move the money from the employer's pre-tax retirement account to a pre-tax Traditional IRA without paying any taxes on the money or penalties for early withdrawal.
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If your retirement account contains taxed funds instead of untaxed funds, you would need to roll the money into a Roth IRA instead. Most employers offer pre-tax 401(k) retirement plans, but taxed accounts are a possibility. It's important to understand the details of your current savings plan before choosing the appropriate type of Rollover IRA. Most Rollover IRAs transfer 401(k) funds to IRAs, but you can also transfer money from existing IRAs and certain other accounts to a Rollover IRA to consolidate your retirement finances.
Why Choose a Rollover IRA?
For most investors who aren't yet retired, Rollover IRAs are something they consider when they leave one job for another and want to close out their employer-based retirement plans. This could be a simple matter of convenience and preference or part of a conscious decision to distance themselves from their previous employers. Financial factors sometimes play a role as well, particularly if existing retirement accounts have fees that a Rollover IRA doesn't have. If your trusted financial advisor recommends a Rollover IRA, ask plenty of questions and discuss the pros and cons before making your decision.
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How to Open a Rollover IRA
Rolling over your 401(k) or existing IRA into a new Rollover IRA isn't difficult, but you need to complete each step carefully. Start by contacting your plan administrator. If you don't know how to do that, contact your company's Human Resources department for assistance. At some companies, a specially trained individual in HR acts as the broker for the employees' retirement accounts. Once you find the right person, arrange a time to sit down with them and discuss the rollover you want to complete. Ideally, you want your company to send the funds directly to your new account to avoid any errors. If they cut you a check instead, it must be deposited in your new account within 60 days to avoid early withdrawal penalties.
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Rollover IRA Taxes and Penalties
If you complete the process correctly and proceed with a direct transfer, you will not have to pay any taxes or penalties to the IRS. Obviously, you want to avoid penalties to ensure your funds don't shrink just because of the rollover. If you receive a check for the funds and miss your deposit deadline for your new Rollover IRA, the IRS will treat your transaction as an early withdrawal of the full amount, and taxes will be due on that money. Additionally, the penalty could be 10% or more if you are younger than 59 1/2 when the withdrawal is made. To avoid possible errors and IRS misreporting, be sure to work with a qualified accounting professional.
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Rollover IRA Risks
As noted above, missing the deposit deadline when transitioning your account could lead to some big penalties. The IRS doesn't offer a grace period or a "break" on these penalties. Other potential risks include the potential loss of some of your final employer contributions and payout shortages due to final tax deductions. If your employer withholds taxes on the amount of your 401(k) closeout distribution, for example, you would have to replace that money when depositing the funds into your Rollover IRA. Be sure to speak with your HR professional about the entire process before proceeding.
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Is a Rollover IRA the Right Choice?
A Rollover IRA could be a great choice for your retirement savings for several reasons. If you're transferring to a new job, rolling over your employer-based IRA or 401(k) to a new IRA makes it easy to keep all your retirement funds in one place, and you won't be penalized if you follow the right guidelines. In the end, it's a personal decision that largely depends on how you want to handle paying taxes on the funds. If you still aren't sure, professional financial guidance is always available.
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How Much Can You Contribute to Your Ira
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