So what about that IRA family? While the TSPs and 401k may seem like practical, simple folk. That IRA family can be as easy to comprehend as a dumpster fire. So today I thought I’d take on the stink, smoke, and confusion and make some sense of the IRA family. First off, remember all IRAs have the same allowed contribution amounts, that’s $6,000 a year, plus an extra $1,000 a year if your age 50 or over. Yes, those numbers are different than the TSP and 401k families. The IRA family is completely separate. And unlike real life, you can hitch yourself to a member of the IRA family AND a member of the TSP or 401k family at the same time, up to the full limit for each.
The first thing an IRA will wants to know about you is how much money do you make. If you’re single and make less than $76,000 a year or married making less than $125,000 a year you can contribute to a Traditional IRA.
Like other retirement plans with a first name Traditional, you don’t pay tax on your contributions when you make them or while your money grows. Your taxes are deferred until you pull it out in retirement. Many people are in a lower tax bracket when they retire, so they pay less taxes overall than if they had paid tax on those contributions while they were still working. But there’s a catch. If you make more than the income limits you cannot deduct contributions. You can court the Non-deductible Traditional IRA but is no great catch. Your contributions are non-deductible which means you will have to pay income tax on your contributions when you make them. The earnings will grow tax deferred. But when you pull it out, those earnings are taxed as regular income. So why would anybody swipe right on that IRA? Sad to say, they often are just using it to get in the family. Then dump old Non-deductible to hit on other hotter sibling Roth IRA, which I’ll get to in a little bit.
Like those other Roths, Roth IRA is tax-free in retirement. You need to leave it in the account for 5 years and be over 59 ½ years old to avoid taxes and penalty though. And what does the IRA family want to know before you start dating one of their own? How much money do you make?! If you are single and earn more than $140,000 or married earning more that $208,000 dollars you can’t contribute directly to a Roth IRA at all. You can’t just go in the IRA family front door, drop to one knee, and propose to Roth. Heartbroken? Well…there is always the backdoor.
The IRS does permit you to rollover money from other qualified retirement plans into a Roth, you just have pay to income taxes on it if you haven’t already. You can choose to rollover contributions from the Non-deductible account into a Roth account and it is transformed into tax-free forever savings. If your savings grew while it was in a non-Roth account, you would need to pay tax on just that increase at the time of the rollover. Some 401k plans allow you to rollover from a Traditional 401k to a Roth 401k. TSP does not allow you to transfer funds from Traditional TSP to a Roth TSP. But you can rollover from any Traditional 401k, Traditional TSP, Traditional IRA or Non-deductible Traditional IRA into a Roth IRA. You’ll pay some taxes on the money you rollover. But after that all the earnings are tax-free.
Depending on the rules of your retirement account, to can transfer or rollover your savings from one to another. You may do this to consolidate your savings in one place. Or you may decide to roll your savings over from a Traditional account to a Roth account to pay some tax now so you can save on taxes in retirement. Check the rules for your specific plan.
Still wondering if a Roth might be the one for you? Tune in next week as we look at some examples and things to consider as you make your big decision.
