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It's IRA Season

It's IRA Season

February 15, 2022


Recently, I have had a lot of conversations with clients regarding IRAs, 401k plans at previous employers, required minimum distributions and things of that nature.  I thought I would share some of what I’m hearing and give you some ideas.


Transferring IRA and 401k accounts


I have had two people in the past week mistakenly tell me you can’t move your IRA or 401k account without a penalty.  One person thought if you were under the age of 59 ½ you would have to pay a 10% penalty if moved your account.  The other person thought they could switch between the funds in the same mutual fund provider but if they moved to a different money manager, they would have to pay taxes. 

Neither one of these is correct.  If you take your money out of an IRA prior to age 59 ½, you will have to pay ordinary income taxes as well as a 10% penalty, but if you do a trustee-to-trustee transfer where you move from one money manager to another or one mutual fund to another, for instance, this will not be a taxable event.  And while you can move from one fund to another in the same mutual fund without triggering a taxable event, you can also do the same trustee-to-trustee transfer like moving from one provider to another without triggering the taxable event.

IRA stands for Individual Retirement Arrangement, and it is covered by IRS tax 408(a).  In the United States, a 401(k) plan is an employer sponsored defined contribution pension account defined in subsection 401(k) of the Internal Revenue Code.  In other words, IRAs and 401(k)s are tax codes.  You don’t buy an IRA.  People will tell me they have an IRA.  I’ll ask, where is it invested and they will respond, it’s in an IRA.  A lot of times I see people who have an IRA at the bank, and it is invested in a savings account or a CD.  I just had a person come in to see me who had her previous 401(k) plan rolled over to an IRA at the credit union.  Since 2014 it has been invested in a savings account that has paid her .25% interest per year.  Luckily, this is something I can help her change.


Should You Move Your Old 401(k)?


I saw this on the internet from a place called Capitalize Research.  They estimated that there were 24.3 million forgotten 401(k) plans holding approximately $1.35 trillion in assets with another 2.8 million accounts left behind annually.  The last time I checked, $1,350,000,000,000 is a lot of money.

I know there are reasons to leave your 401(k) at your previous employer.  You might be happy with the returns you have received.  It might be less expensive to keep your money in the company plan versus moving it to your new employer’s plan or move it to an IRA.  However, after seeing the statistics above, it might make sense to explore your options.

The average person changes jobs 12 times during their career.  The average employee stays with an employer 4.1 years.  I bet this contributes to the forgotten 401(k) problem.  Another issue that you might not realize is, when you have to start taking required minimum distributions, you need to take a distribution from each of your separate 401(k) plans.  So, if you have $100,000 in one 401(k), $200,000 in another and $200,000 in one more, you can’t aggregate the $500,000 and take the RMD from one account.  You must take a separate RMD from each 401(k) plan. 

Besides the problem of having lost 401(k) plans and the RMD issue discussed above, other reasons for consolidation are choice and control.  With a 401(k) plan, the plan sponsor chooses the recordkeeper as well as the fund lineup.  It is their fiduciary duty.  While that might be okay, you as a former employee have no control over what they choose.  When you have your own IRA, remember, Individual retirement arrangement, you get to decide where to invest your money.  If you aren’t happy for some reason, you can make a change whenever you want.  There’s a lot more to this subject, but this points out a couple of things to consider.


Who Can Contribute to an IRA?


The answer to this is, Anyone!  Anyone can contribute to an IRA regardless of their income or whether they are covered by an employer sponsored plan or not.  The question is whether you can make a deductible IRA contribution or are you able to make a Roth contribution?  This depends on your income, your marital status and your participation in an employer sponsored plan.  The IRS has rules for people not covered by an employer sponsored plan.  Married people where one of the spouses is covered by a plan as well as married people where both spouses are covered by a plan.  We have charts that can help to decide if you are eligible for a deductible IRA, or a Roth IRA contribution based on these rules. 

That being said, everybody can do a non-deductible IRA contribution.  This is an IRA where you make a non-deductible contribution, the money grows tax deferred, and you pay taxes on the growth on the account when you take distributions.  One thing you do not want to do is mix a non-deductible IRA with a deductible IRA.  It will create an accounting headache in the future.

You Still Have Time to Make Your IRA Contribution


I’m writing close to the middle of February.  You are eligible to make a previous year IRA contribution up to your tax filing deadline, which is Monday, April 18th, 2022.  For most people their 401(k) contributions are based on the calendar year, but you have a few extra months to make your IRA contribution.


Age 59 ½


Most people have heard you can take distributions from your IRA and 401(k) plans after the age of 59 ½ without having to pay the 10% penalty.  Here’s one you might not know.  If you are a participant in your company’s 401(k) plan you can rollover your 401(k) assets to an IRA after the age of 59 ½.  Many 401(k) plans have rules that prohibit an in-service withdrawal from the plan.  This means, if you are working at the company, you cannot take a distribution from the plan while you are still employed.  However, if you are age 59 ½ or older, you can still take a distribution.  If you take it out and spend it, you will have to pay ordinary income tax on the distribution, but if you roll it over to your IRA, there is no 10% penalty, no ordinary income tax and you avoid any in-service distribution rules the plan may have.


In Conclusion….


IRAs and 401(k) plans have a lot of rules and can be super confusing.  While I know quite a bit about this stuff, I don’t know everything, but I can get the answer.  Because it somewhat confusing and everybody’s situation is different, the best thing is to sit down with somebody, discuss your situation and figure out the best course of action.  If you want to talk to me, you can schedule a time to talk HERE.  As always, thanks for reading!  KB