How to Open a Roth IRA That Fits Your Situation?
Honestly, almost nobody thinks about retirement when they have just graduated from college. You land your first job and your benefits package likely has things you never even heard of before. Along with learning how to handle money, you need to learn about the insurance and available account types.
Better packages offer accidental death and dismemberment insurance and long-term care insurance. They also typically include a retirement account.
Now, at 22, you probably have not given due consideration, as my dad would have said, to retirement or incapacitation. Instead, you probably focus on that week or two of paid vacation you get every year.
Oh yeah. I know.
Your Guide to Opening a Roth IRA
I may be 51 years old now, but I had my days of spring breaks at the beach and I really loved the paid vacations when I worked in academia. More beach time. Another plus was that social media did not exist then.
So, as you skim down the list of benefits, pay close attention to the retirement account options. Your employer may give you a few. If you work in academia in the US, you will have a different set of options. The most common three options in any scenario are:
401(k),
403(b),
Roth IRA
Ok, so we’re going to tell you all about How to open a Roth IRA and you can skip right to it by scrolling to the bottom of this article. BEFORE you jump there though, we recommend taking the time to read what’s in the next few sections first. A careful review of what a Roth IRA does and doesn’t do will help educate you on your options before opening one up. After all, my job is to educate with insight on how to make important financial decisions.
The Difference Between the Retirement Account Types
You have probably read enough online or at the office to know that you have a multitude of choices when it comes to retirement accounts. The best personal finance app will even offer some of these account types today. For instance, Stash or Acorns offers these types of accounts. Rather than discuss every type herein, I will only regale you with the three most common types.
401(k)
For-profit companies typically offer a 401(k) rather than a pension. This practice began in the 1980s and has increased in popularity. Your employer chooses investment options, you create the account, funding it with pre-tax automated withdrawals from your paycheck. You create a portfolio and decide at what risk level you want to invest.
While a 401(k) always carries some risk since you play the stock market with your money, you can pick less risky investments. This account type has a cap on contributions that change annually. This cap, set by the Internal Revenue Service, is $19,500 in 2020 for individuals up to the age of 49. Individuals aged 50 or older, may contribute up to $26,000. Contribute between 10 to 20 percent of your gross salary up to the cap annually to fund your potential retirement. You can also establish a 401(k) independently, as a self-employed person.
403(b)
Public schools, colleges, universities, churches and 501(c)(3) non-profits offer 403(b) plans, a type of retirement plan known as a tax-sheltered annuity plan. It works in a similar way to a 401(k) so employees still get to defer a portion of their salary into the annuity account. The contributions are not taxable until distribution, meaning you won’t pay taxes on any of the money until you withdraw it at retirement. Your 403(b) plan may let you contribute to a designated Roth account. The money you put into a Roth tied to the 403(b) remains tax-free at distribution but is taxed when you deposit it.
Roth IRA
Roth IRAs provide tax-free money during retirement. While the money you contribute does get taxed when you deposit it, this can work to your benefit since it is typically the first retirement account one opens and used by those at the start of their careers who are making less money. While in a lower income bracket, you pay less in taxes. When you access the money years later while in a higher tax bracket, you do so tax-free. This account type is for those earning $122,000 or less annually. You can only contribute $6,000 per year, but there are no required minimum distributions.
Once you reach retirement age, it is yours to use as you wish. You can also leave it untouched and leave it in your will and testament as tax-free income to your beneficiary. Unlike some other types of retirement plans, there is no age limit for creating a Roth IRA. You can create one as a self-employed individual or your employer may offer one. Many employers match your contributions or contribute a set amount each month or year to your account. You must keep your Roth IRA for five years minimum before drawing from it.
Reasons to Use the Roth IRA Option
So, now you probably get why you hear about Roth IRAs so often. There’s a buzz. It’s a pretty buzzworthy account.
Anybody Can Open One
Yippee! Even if you work for yourself, you can nab a retirement account. It even saves you money down the line since you pay no taxes on it when you use the money in your retirement. You will love that once it is what you are living off of it many years from now.
You can also open one in conjunction with some other types of accounts. Sure, there is that $6,000 cap on annual deposits, but when you start out in your career that really does not matter. When you start out making $25,000 to $30,000, do you really plan to invest more than one-fifth or one-sixth of your income?
Probably not. You should really only stick 20 percent at a maximum of your snazzy annual income into retirement savings, so the 6K cap does no harm.
Finally, you can create a Roth IRA from an existing type of other retirement accounts. In finance, they call this ‘rollover’. You can rollover a traditional IRA into a Roth IRA, for example. So, how do you roll over an existing retirement account into a Roth IRA? That’s next.
Rolling Over Your Existing IRA
You may be able to roll over your IRA into a Roth IRA plan. Note the word may. It’s not a sure thing. You may not get to open a Roth IRA with your existing retirement money.
So, how do you know?
Your retirement plan language will state whether or not you may roll over your existing account into another type.
If your existing account plan says you may roll over, you can roll your traditional IRA, also called a 401(k) plan, into a Roth IRA. Here is a big, however. You may only rollover an existing Roth IRA into another Roth IRA.
I hear you.
You just said, “What the hell is the point in that?” Every IRA is different, just like every snowflake is different.
A Roth is simply a type of account. Every employer that offers a Roth tailors its options to that company. The same is true of every 403(b) and 401(k).
Typically, as was with my 403(b), you get to pick and choose lots of aspects of the account, including which company out of four or five choices will manage it. I did not have to choose TIAA-CREF, for example. I could have gone with Vanguard or two other choices.
Within each of the companies you could choose to manage your account, you will have umpteen other options. Many offer a low-risk money market account option. They will also offer medium- and high-risk options that play the stock market. Some will be exchange-traded funds (ETFs) that model an index to potentially leverage higher yields. You get to see the stocks or the index used before making a choice. Some management companies offer specialized choices, such as eco-friendly funds or Fair Trade funds. Every business that these funds include meets certain criteria before getting included in the fund.
All of this adds up to mean that every Roth IRA differs from the others. So, you might move from one job to another and find that although both companies offer a Roth option, the second company’s Roth offers more flexibility or investment options or a specialized fund or the ETF of your dreams. As long as your initial retirement account already vested, you can rollover the account.
Vested?
Yep. Vested.
What Does ‘Vested’ Mean?
The term refers to the portion of the retirement account that belongs to you. Typically, in 401(k) plans, the money you contribute automatically belongs to you, but the part that your employer contributes only belongs to you after a certain period of time during which you must remain an employee of that company. This can be a kind of a long time. At the University of Oklahoma, for example, it was three years before a 403(b) vested. This is to protect employers who make regular contributions to your retirement from you quickly jumping from job to job. It encourages organizational loyalty.
Now, you do not have to roll it over into a Roth. If you spot an opportunity to open a Roth IRA that could benefit your savings and investment though, jump on it as long as you are allowed to do so.
When You Can’t Roll Over
It happens.
Sometimes, you just can’t. Maybe your cat or dog is in the way. I’m joking.
But, really. In some very specific situations, IRS regulations do not allow you to roll over your funds regardless of the employer’s fund rules. Here are the exceptions to the distributions that you can rollover:
it is one of the required minimum distributions from the account
when you obtain a loan based upon the IRA’s balance because the IRS sees this as a distribution
a hardship distribution such as those made for a medical emergency
a distribution of excess contributions and/or their related earnings
a distribution from a series of equal or nearly equal payments
withdrawals electing out of automatic contribution arrangements
distributions for payment of insurance premiums for accident, health or life policies
dividends on employer securities
distributions of S corporation allocations
If you closed out your traditional IRA after it vested though because you changed jobs or lost your job, etc., you can open a Roth IRA.
Start Taking Care of Your Finances on Time.
The Wealthry Store Is Here for You.
Roll Over Time Periods
While your rollover does not have to be immediate, you also do not get to wait very long. You must open the Roth IRA within 60 days of the distribution date.
Pretty much the only exception ever for this 60 day period is if your financial institution created the disbursement or closed your existing account in error. You still have to meet other conditions. The exception and other conditions are rather complicated and somewhat convoluted, so you may want to read the book about it.
No, I am serious. There is a book. The IRS pithily titled it “Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs) and Retirement Plans FAQs relating to Waivers of the 60-Day Rollover Requirement.” You may download it from the IRS website, irs.gov. It is free. Happy reading.
How To Roll Over Your Traditional IRA to a Roth IRA
You have a few options for rollover or as it is also called a conversion. Choose one of these three methods:
Rollover
Within 60 days of a distribution from your traditional IRA, you contribute it, also known as deposit it, to a Roth IRA. In this method, the check is made payable to you.
Trustee-to-Trustee Transfer
You transfer the assets in your traditional IRA from your current financial institution directly to the trustee of the Roth IRA at another financial institution. In this method, the check is issued to you but made payable to the new trustee.
Same Trustee Transfer
You can directly transfer your funds from a traditional IRA to a Roth IRA when both accounts are held at the same financial institution.
Here is the one caveat. When you convert from a traditional IRA to a Roth IRA, you will incur taxes of any of the traditional IRA’s untaxed amounts.
When you convert from one account to the other, you also incur extra paperwork. You must report the conversion to the IRS. Of course, they have a form for this. (Trust me. They have a form for everything.) You will need to file Form 8606, Nondeductible IRAs. The pithily titled book I mentioned above tells you all about it.
Details on How To Open a Roth IRA
You probably wondered when I was going to tell you how to open a Roth IRA, but, let’s face it. This is a really complicated process and you do have to know a lot about retirement accounts before you get to this point. There is no need to open one if you do not actually need one. So, here are the steps to opening your Roth IRA.
Not everybody can open a Roth IRA. It was developed for people who earn less than $122,000 per year or $193,000 for married couples. The maximum salary changes annually. The numbers I shared were for the tax year 2019. You need to be okay with a maximum annual contribution of $6,000 until you hit the age of 50.
At that point, you get to sock away an extra $1,000 a year. Should you exceed that, uh-oh. The IRS will charge you a six percent excise tax on the excess. You can avoid the tax if you withdraw the excess contributions before Tax Day, also known as April 15th. That date is also the cutoff for contributing to one for the current tax year, so if you open one on April 14th and deposit 6K, you change your tax situation for that year. If you open one on April 16th, you change it for the coming tax year.
This is a company at which you want to open your Roth IRA account. Pretty much every investment company offers one. Consider the fee to establish or maintain the account and if the firm offers online or telephone customer service. Also, make sure the company offers the investment types you desire, such as actively managed funds, ETFs, stocks and bonds, and/or target-date funds. Also, consider their cost per trade fees and your expected transaction frequency.
Nowadays, you can do this online at most banks and brokerages. Legally, they must require you to provide your driver’s license or other acceptable photo identification, your Social Security number, your bank’s routing number and your checking or savings account number, as well as your employer’s name and address. You also must provide your beneficiary’s name, address, and Social Security number. You must also complete the IRS form 5305-R as a part of the application process.
You can ask your brokerage for advice on this, but you must ultimately decide where the heck you put your money. You can pick a selection from the bank or brokerage’s existing options or choose a target-date or life-cycle fund or work with a financial advisor on custom picks.
Conclusion
So, now you can go open the Roth IRA you always dreamed of having. You can begin saving for that awesome time when you either decide to travel, settle down or retire from one career to start another one or two or three. Hey, it happens.
Start saving right now. Find the best savings solution and improve your personal finances. We prepared some suggestions for you: