The Best Rollover IRA for Retirement! Rollover 401k to Roth IRA or Traditional IRA?

What Are Your Tax Friendly Investment Options? IRA Contributions, IRA Rollover Restrictions, Taxes, Rates and Withdrawals

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Rollover 401k to Roth IRA or Traditional IRA?
What Are Your Tax Friendly Investment Options?

You are probably on this page because you are interested in an IRA for your retirement but are confused about which kind is the best IRA. So, let’s start with the basics.

IRA stands for an Individual Retirement Account. All IRAs are designed for funding retirement and each provide tax advantages. Technically, most IRAs are Traditional IRAs, Roth IRAs, Sep IRAs or SIMPLE IRAs -- although other adjectives are often put in front of “IRA” to define different ways of opening an account or using the funds.

Most people around retirement age are interested in a Rollover or Consolidation IRA – converting their 401k assets to a Traditional or Roth IRA or consolidating their retirement assets with one institution.

As such, Traditional IRAs or Roth IRAs are generally the options for retirees interested in rolling over or consolidating their 401k or other employer sponsored plan.

The differences between Traditional IRAs and Roth IRAs are related to:

  • How much you can contribute and when
  • How much you can withdraw (cash out) and when
  • When and how you pay taxes on the principal
  • When and how you pay taxes on interest earned.
  • Who can contribute money to the fund
  • How the money can be invested

Definitions of Traditional IRA and Roth IRA -- IRAs for Rolling Over or Consolidating Retirement Funds

If you are rolling over or consolidating your retirement funds, you will most likely be opening either a Traditional IRA or a Roth IRA. The differences between these two accounts are outlined below.

  • IRA or Traditional IRA: The most popular kind of IRA. And, the type of IRA most often used for rolling over or consolidating retirement funds.
    • Taxes on Contributions: Contributions are tax deductible. (Meaning that you do not pay taxes on the money you invest in an IRA when the money is invested.)
    • Taxes on Interest/Earnings: However, taxes are paid on the principal as well as the earnings (money earned from the principal) when withdrawn from the IRA.
    • Maximum Contributions: Maximum contributions for the years 2009-2010 are $5,000 indexed for a cost of living adjustment (COLA), plus $1,000 as a "catch up" for those over 50 years of age. However, Rollover IRAs have no limit – any rollover amount can be contributed.
    • Withdrawals: Withdrawals (also known as distributions) can begin at age 59 1/2 and are mandatory by 70 1/2. (Withdrawals before age 59 and a half are usually subject to a 10 percent penalty.)
    • Investing Options: Funds can be used to purchase a variety of investments
    • Eligibility: Can be opened by anyone.

  • Roth IRA:
    • Taxes on Contributions: You do pay taxes on the money that you contribute. Contributions are NOT tax deductible.
    • Taxes on Interest/Earnings: Taxes are NOT paid on the earnings you receive in the account.
    • Maximum Contributions: For 2008, the maximum contribution to a Roth IRA is $5,000 ($6,000 if you're 50 or older by the end of the year). And, starting in 2009, contribution limits will be based on inflation, increasing in $500 increments, though for 2010-11, there are not expected to be any adjustments, due to the low inflation rate.
    • Rollover Options: If you are rolling over a 401k to an IRA and wish to open a Roth IRA, you must first rollover your funds to a traditional IRA and then convert that to a Roth IRA. The rollover will however likely be taxed and you must earn less than $100,000 a year in order to this.

      IMPORTANT NOTE FOR YEAR 2010: In 2010 there will be an exception to the income limits and taxes for Roth IRAs. Anyone at any income level is eligible to convert their Traditional IRA to a Roth IRA in 2010. And, if you convert your IRA to a Roth in 2010, you won't have to pay any taxes on the conversion that year. You'll be allowed to pay half your tax bill in 2011, the other half in 2012.

      These exceptions apply only to conversions in 2010.

    • Withdrawals: Withdrawals can be taken anytime without penalty and there is no mandatory distribution age.
    • Investing Options: Funds can be used to purchase a variety of investments.
    • Eligibility: A Roth IRA is only available to single-filers making up to $95,000 or married couples making a combined maximum of $150,000 annually.

Rollover IRAs, Consolidation IRAs and Other Definitions Related to Traditional and Roth IRAs

  • Rollover IRA: Typically, a Rollover IRA is the same as a Traditional IRA. The difference is that instead of making a contribution from your earnings, you are converting your 401k or other qualified account into an IRA. You can also rollover an existing IRA from one financial institution to another.

    As such, there is no maximum contribution. All qualified funds are eligible. Experts usually recommend that most retirees convert and consolidate their 401ks into a Rollover IRA at retirement.

  • Consolidation IRA: A Consolidation IRA is not a specific kind of IRA. It simply refers to consolidating your numerous retirement savings accounts like IRAs, 401ks, 403bs and 457 plans with one financial institution.

    There are numerous benefits to consolidating your retirement accounts at retirement. The most obvious benefit is that having one account can make retirement planning – and maintaining your overall retirement strategy simpler. Other benefits include: simplified tracking, streamlined paperwork and lower maintenance costs. Consolidation also makes it easier to calculate what distributions you must take.

  • Direct Rollover IRA: With a Direct Rollover, a check for your retirement funds is made payable to the new IRA custodian or financial institution. This is the preferred way to conduct a rollover since there is no chance of there being tax consequences as is possible with an Indirect Rollover.
  • Indirect Rollover IRA: An Indirect Rollover can be tricky since the check for your retirement funds is made payable to you and taxes may be withheld. To protect yourself from owing taxes, you must forward the money within 60 days to the new IRA custodian.
  • Inherited IRA: If you have inherited or are the beneficiary of an IRA and you do not wish to use the money and pay the required taxes immediately, you may want to roll it over to maintain the tax-deferred status on the account.
  • Self Directed IRA: Most IRAs from banks, insurance agencies and mutual funds offer financial advisors as part of the package. With a Self Directed IRA, you make the investment decisions on your own.

    Both traditional IRAs and Self Directed IRAs allow you to invest in stocks, bonds and a wide variety of other options, but depending on your brokerage, a Self Directed IRA gives you even more options like real estate and small business investments. This type of account is really for a savvy investor who is willing to take on more risk.

SEP-IRAs, Simple IRAs, 401(k), 457(b), 403(b) and Other Employee Sponsored Retirement Accounts – Accounts for Accumulating Retirement Assets

SEP-IRAs, Simple IRAs, 401ks, 457s and 403bs are all employer sponsored retirement savings accounts.

Each of these plans is designed differently with varied rules and regulations. However, they are all designed to help employees save for retirement.

  • Simple IRA: A Simple -- “Savings Incentive Match Plan for Employees” -- IRA is more like a 401k than an IRA in that it is an employer sponsored plan. A Simple IRA is available to employers with no more than 100 employees. It is less costly to administer than a 401k.
  • SEP-IRA: SEP-IRA stands for Simplified Employee Pension Individual Retirement Account. SEP-IRAs are often used by self employed persons and small business owners to provide retirement benefits to themselves and their employees. SEP-IRAs are particularly interesting because they have relatively high contribution limits.
  • 401k Plan: 401(k) Plans are typically offered by private sector corporations who wish to help their employees save for retirement.
  • 457 Plan: A 457 Plan is a tax advantaged retirement account that is available to government workers – as well as qualified non-government organizations. The 457 plans are similar to 401ks.
  • 403(b): A 403(b) Plan is a tax advantaged retirement account available to public education organizations and some non-profit employers.

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