Should I Rollover My 401(k)?

Reader Jeff is switching jobs and wondering, given the market’s drop the last few months, if he should roll over his 401(k) to a Rollover IRA. His concern is that he’d be “selling low and buying high” in that situation and didn’t know what he should be doing.

I’m not a retirement nor an investing expert but I can say that your biggest concern shouldn’t be the performance of the market, it’s the volatility. With the various indicies gaining and losing large single-digit percentage points on a daily basis, it’s the volatility that is the big concern. A rollover takes time. Depending on how quickly or slowly you, your 401(k) administrator or your Rollover IRA administrator is, you could be left waiting for many days on the sideline as your 401(k) assets as liquidated, transfered to you, then transfered to the Rollover IRA. In that time, the market could go down big, go up big, or go sideways pretty erratically. My point is that the volatility is unpredictable, so on that basis alone, without any other compelling reason, I’d stand pat for now.

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McCain & Obama Propose IRA & 401(k) Rule Changes

With the recent cratering of the stock market, both Presidential nominees have proposed changes to IRA and 401(k)s that would allow for both early withdrawals, up to certain limits, and suspension of the required minimum distribution rules. Jeremy at GenXFinance hated the idea but I think offering the option, especially since we are headed towards certain stagflation (inflation for the trailing 12 months before August 2008 was a staggering 5.9% and unemployment was rising). People are going to be strapped. Offering the option of the lesser of two evils is better than forcing people to take drastic measures.

Here are the proposals:

McCain: “Temporarily suspend mandatory annual withdrawals. Current rules require investors to start selling stocks at age 70½. Allow savers who are younger than 59½ to withdraw up to $50,000 at the lowest tax rate of 10 percent in 2008 and 2009.”

Obama: “Temporarily suspend mandatory annual withdrawals from Individual Retirement Accounts and 401(k)s. Current rules require investors to start selling stocks at age 70½. Exempt withdrawals made up to the required minimum amount from taxation. Allow savers to withdraw 15 percent, up to a maximum of $10,000, without paying a penalty as the law currently requires for withdrawals before age 59½. These withdrawals are subject to normal taxes.”

(You can read all of their economic & tax proposals at the New York Times)

I think the suspension of required minimum distributions is crucial and I’m glad the candidates both agree on that. It’ll be the biggest help to those nearing retirement because they won’t be forced to liquidate those stocks that have lost value.

As for the second piece, of the two, I prefer Obama’s proposal because it offers 15%/$10,000 (rather than $50,000) and it is subject to normal taxes as opposed to 10%. McCain’s proposal of dropping the tax rate on withdrawals to 10% is too attractive. All of my 401(k) contributions were done in the 25% tax bracket, I’d have a huge incentive to withdraw my money because I’d immediately see gains because I would only pay 10%, not 25%. (should either proposal ever become law, I wouldn’t withdraw money unless I absolutely needed it though)

Don’t get me wrong, I still think withdrawing funds from your retirement account is a huge mistake. But people will be in trouble and they will either turn towards credit cards and dangerous loans, or they will withdraw the money anyway and simply be left with less of it. It’s truly the lesser of two evils.


Roth IRA Workaround: 2010 Conversion Limit Loophole

Retirement Nest EggsCan’t contribute to a Roth IRA? There’s a workaround.

I was speaking my accountant a few weeks ago when we began discussing retirement options. One of the ideas we discussed was to contribute to a non-deductible Traditional IRA with the plan of converting it into a Roth IRA in 2010. Prior to 2010, if you earned more than $100,000 MAGI, you cannot convert a Traditional IRA to a Roth IRA. This limit is the same whether you’re married or single (boo!). Starting in 2010, that rule disappears so anyone of any income can convert (more on the 2010 traditional IRA conversion income limit loophole).

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7 Deadly Sins of Personal Finance: Raiding Retirement

7 Deadly Sins of Personal FinanceThis is the second deadly sin of personal finance (the first deadly sin was failing to have an emergency fund) and one that some of our friends have been thinking about “committing.” We’re all in our late twenties and buying our first homes. Despite what the experts say, home prices are still very high in the Baltimore and Washington D.C. areas, barely within affordable reach for many people our age. So, our friends are looking for places they can tap to help with a down-payment.

Inevitably, they learn about how they can borrow (or worse, withdraw and be penalized) from their 401(k) to help with the purchase of their first home. This leads right into the second deadly sin of personal finance:

Don’t Raid Your Retirement Funds

Remember when you were a kid and your parents planned a vacation? Part of the fun of the entire vacation was the anticipation of going on a trip. The excitement the night before as you couldn’t sleep, the energy you had packing for the journey, and the planning of events beforehand. In talking to colleagues, retirement is very much like that. You plan new hobbies to try, new events to attend, and new places to see. When you raid your retirement fund, you put all that in jeopardy. You have to slide back the day you hope to retire. It’s devastating and demoralizing.

Sometimes you can’t help it. A lot of people who hoped to retire last fall are continuing to work because their retirement investments fell. I’ve chatted with at least one person who thinks they’ll have to work a few more years just to get back because they were over-exposed to equities. In his case, he was too aggressive and he came up craps on the roll of the dice. With so many other potential problems, why make things harder for yourself by stealing early from the cookie jar.

You need that money if you ever want to stop working. As Gary Bonner, a contributor of BFP, once wrote in Making a Living? Or, Making a Life?: “no one has ever laid on their death bed saying ‘I wish I had spent more time at the office.'” We want to stop working as much as we want to have a new television, or a new pair of shoes, or a bigger house. However, every single time you take money from your retirement fund, you’re extending the time you have to spend at the office.

$1 today is ~$22 in forty years. At a conservative 8% annual appreciation, every dollar you take out now is worth $21.72 in forty years. Twenty-two bucks may not seem like a lot but you have to think of it as a multiple of twenty-two. $100 is $2,200. $1,000 is $22,000. Is the sacrifice worth it? In most instances, no. There is no clear cut answer in the rent. vs. buy question. With so many different situations and scenarios, you can’t clearly say that one is vastly superior to the other. But I can say, without a shadow of a doubt, you will need your retirement funds in retirement and every dollar you take today will steal $21.72 from you in forty years. That’s just math.

Like everything else, it’s not black and white. If you have a major medical emergency and it’s exhausted your insurance and your emergency fund, you won’t have any choice. You will have to raid your retirement fund. My opinion is that it better come to that and I will have to be in very desperate shape before the retirement fund comes into play.


Rollover 401K into Traditional, Then Convert To Roth IRA?

I have a 401k from my former employment. My CPA says to turn into a traditional IRA and then over to a Roth IRA for tax benefits eventually. He suggest investing in a very low risk A bonds and 25% low risk stock.

His reasoning is we are only taxed now on the lower end of balance, but later as it grows will be beneficial to us then.

I am 52. I plan on using the funds after 59.5 yrs.

1. Is there always a fee connected with rolling over into an IRA — bank, cpa, etc.

2. Does this sound like a wise?

I am very conservative in my finances.

Your question has three parts actually:
Should you roll over a 401k to a Traditional IRA?
If you think that the Traditional IRA gives you access to better investment options, then yes you should roll it over. The tax rules are the same for a Traditional IRA (in this case it’s called a Rollover IRA) and a 401k. There is generally no fee associated with rolling over an account.

Should you convert a Traditional IRA into a Roth IRA?
When you convert, you pay taxes on the entire Traditional IRA balance because you didn’t pay income taxes on that amount before you contributed it. If you remember, your 401K contributions were deducted from your paycheck, thus making it tax-free; and since Roth IRA funds are post-tax, they extract the tax when you make the conversion. Will this be beneficial to you? Only if you think that your income tax rate will be higher that it is now when you’ll be withdrawing the funds in seven years. Only you know that so I can’t tell you what I’d do in your situation.

A subquestion to the “whether you should convert question” is how you’d pay for it. You can pay for the tax with funds outside of your IRA’s or you can pay using the principal within the IRA. If you need to tap into the principal to pay for the tax, I probably wouldn’t do the conversion because you’re sacrificing earning potential when you decrease that principal. If you can pay for the tax outside of the IRA, then you have a decision on your hands.

Does this sound wise?
It only sounds wise if you want to go through the trouble (or are willing to pay this CPA to do it for you, which has a lot to do with why he or she suggested it for you) and if you think your income tax rate will be higher in seven years. Luckily your conservative investment style has nothing to do with this, if you think you’ll be taxed more in 7 years and you can pay the tax with funds outside of the IRA, then you probably want to convert. If you don’t think you’ll be taxed more in 7 years, don’t do it. If you don’t think you can pay for the conversion (which will cost you your tax rate times whatever you convert), don’t do it.

Good luck!


Traditional and Roth IRA Contribution Limits

I know this is somewhat elementary stuff but I’ve been getting a lot of searchers looking for these contribution limits and they’re going to pages that don’t display it in a convenient and easily scannable format – thus, I’ve written this entirely new post to address these limits.

Contribution Limits:

Year Under 50 Limit Over 50 Limit
2006-2007 $4,000 $5,000
2008 $5,000 $6,000
2009 $5,000 $6,000
2010 $5,000 $6,000

Roth IRA Income Phase-out:

Year Floor Ceiling
2008 Single $101,000 $116,000
2008 Married F.J. $159,000 $169,000
2009 Single $105,000 $121,000
2009 Married F.J. $166,000 $176,000
2010 Single $106,000 $121,000
2010 Married F.J. $167,000 $177,000

Some rules:

  • The Over 50 Limit takes into account a catch-up contribution you’re allowed to make if you turned 50 at any point during the year, so if you turned 50 on December 31st, then you’re allowed to contribute the Over 50 Limit. Your contribution is also limited by your income, you are permitted to contribute the lesser of your income or the limit (so if you made $500 in income, you’re only allowed to contribute $500 to your IRA).
  • Traditional and Roth IRAs share the same limits, thus if you contribute $1,000 in 2008 to your Traditional IRA, you may only contribute an additional $3,000 to your Roth IRA (assuming you’re under 50).
  • The Roth IRA income phase-out is linear, so if you are Married Filing Jointly, under 50, and your total income were $164,000 (2008), you are permitted to contribute $2,500 to your Roth IRA. There are two special cases though: 1) when calculating your limit, round up to the nearest $10; 2) If your limit is under $200 but still positive, round up to $200.


Rolling Over My 401(k) To Vanguard

Today, I severed one of my last ties to my old job, my 401(k) plan. The process for rolling over my 401k to a Rollover IRA at Vanguard was fairly painless but there are several areas that you need to keep an eye out.

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Making Your 2004/2005 Roth IRA Contributions

It’s now January 12th (no significance, you could’ve submitted it on Jan 1st.) and both financial slackers and overachievers can make contributions to their Roth IRAs. For the slackers who have yet to contribute to their 2005 Roth IRA, you have until April 17th to contribute the maximum limit of $4,000. If you’re a slacker and happen to have been around for more than 50 years, then you can put in $4,500 towards your 2005 contribution. If you’re an overachiever, you can contribute up to $4,000 to your 2006 Roth IRA contribution limit. For the the 50+ crowd, the catch-up clause permits you to contribute $5,000 to the 2006 Roth IRA contribution limit.

Some things to remember:

  1. If you mean to contribute towards your 2005 limits, make sure you notify the company managing your Roth IRA. They will, by default, put it towards 2006. If you forget, no big deal, just notify them as soon as possible and they’ll remedy it.
  2. Depending on whether you’re a lump sum believer or a dollar-cost averaging believer, you don’t have to contribute to your Roth all at once. I personally am a lump sum believer and here’s why.

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