In addition to your employer sponsored 401(k) you can fund a self-directed retirement account. An Individual Retirement Account (IRA) is a retirement account that you can set up and manage yourself. Like the 401(k), there are certain tax deferred benefits if you agree not to withdraw money until retirement age.
There are three types of IRAs:
- Traditional Non-Deductible IRA offers tax-deferred growth, meaning you pay taxes on your investment gains only when you make withdrawals during retirement. You fund this retirement plan with after-tax dollars. You quality if you have earned income. You are required to begin taking withdrawals at 70 ½ years of age.
- Traditional Deductible IRA offers tax-deferred growth as well. You are eligible for this retirement plan if you do not qualify for your employer's retirement plan or your modified adjusted gross income is less than $60,000 if you are single or $80,000 if you are married and file jointly. You are required to begin taking withdrawals at 70 ½ years of age.
- Roth IRA is funded with after-tax dollars, therefore you don't owe tax on any earnings as the account accumulates. Thus, you enjoy tax-free growth. You can withdraw your earnings tax free once you reach 59 ½ and your account has been open for five years.
Opening an IRA
Opening an IRA is an easy thing to do. You can get the forms from your bank, brokerage firm, mutual fund provider or any financial services firm. Different IRA providers offer a range of IRA investment options. It is important that you find one that meets your needs. For example, you may want your portfolio to include stocks, bonds, certificates of deposit (CDs) or mutual funds. Whatever your preference, be sure your IRA provider meets your needs.
In 2010, you can contribute up to $5,000 annually or $6,000 if you are over 50 years old. In addition to the standard contribution, there is also a catch-up contribution limit. If you are 50 or older in the calendar year, then you are eligible for an additional catch-up contribution of $1,000. This means that the standard contribution of those ages 50 and older can contribute is $6,000 + $1,000 or $7,000.
Switching Jobs
When you switch jobs, it's a good idea to move the money from your old employer's 401(k) to an IRA. This gives you optimal control later on. However, if you like the performance of your old employer's 401(k) you may be able to leave your money there if you have over $5,000 in the account. Check with your former employer to confirm their terms and conditions.
If you decide to move it, be sure to do so as a trustee-to-trustee transfer. This simply means that you never touch the money. You just direct your old 401(k) provider to transfer the funds to an IRA provider of your choice. You will have to provide the account details and sign. That's it.
Avoid the costly trap of having your former employer write you a check which you are supposed to deposit within 60 days into your new IRA account. This sounds simple enough; however, your old employer automatically withholds 20 percent of your money for income taxes. You get it back when you file taxes the next year, but you lose the option of having that money work for you by growing in your new IRA account.
If for some reason you do fail to rollover the money into the new IRA within the 60 day time limit, the IRS deems this as a taxable withdrawal and imposes taxes plus a 10 percent penalty. Do not let this happen to you!