One recent poll by Putnam Investments showed that retirees most regret not saving in retirement accounts outside of work. With that in mind, are IRAs underutilized?
An IRA is generally where retirement funds end up. When you retire, you generally roll them into an IRA. That's the destination for retirement savings. But yes, they are. People don't think to save outside of work or they think they make too much money to open an IRA. Roth IRAs are especially underutilized. Everyone who can should open a Roth.
The Roth IRA is your favorite IRA. Why?
Because money in a Roth grows tax-free forever. You fund it with after-tax dollars but you never pay tax on earnings again. And you don't ever have to take money out, so it can keep growing. Most workers can qualify for a Roth IRA. But eventually, everyone will qualify for them in 2010, thanks to last year's Tax Increase Prevention and Reconciliation Act. It lets everyone convert an IRA to Roth if they want to in 2010. So try to put as much money in now as you can. And in 2010, you won't pay tax on the conversion. Instead, you'll pay half the tax in 2011 and half in 2012. It's a great deal. The government is giving everyone a one-time interest-free loan to build tax-free savings accounts. It's like they're giving you a free ride. If you really want to build up retirement savings and have it come out tax-free, do this.
Tell us more about Roth 401(k) plans, which are now starting to be offered by employers. Are they a good deal, and if so, for whom?
They're similar to a Roth IRA except you put after-tax money from your earnings through an employer's plan. It's a better deal than a Roth IRA only because you can put more money in -- up to $15,500 or $20,500 if someone's 50 or older. IRA limits are $4,000 and $5,000 for someone 50 or above. I'd recommend it instead of 401(k) but a company has to offer it. I think more companies will. It costs you money upfront because you won't get the tax deduction for contributions but, in the long haul, you'll do much better since you won't owe taxes again.
When is a rollover not a good idea?
There are times when you may be better off to take a lump-sum distribution or leave it in the plan. For example, let's say you're age 55. There's a special rule that if you separate from service at 55, you can withdraw funds penalty-free. If you had rolled money over into an IRA, you'd have to wait until you're 59½ to avoid the (10 percent early withdrawal) penalty. This special rule only applies to employer plans like a 401(k), 403(b) or a 457. It doesn't apply to an IRA. And you have to be separated from service. That means you can be fired, quit, retired, but it has to happen in the year you turn 55 or older.
What's the best way to avoid rollover headaches?
With a direct trustee-to-trustee transfer, a 401(k) moves directly to an IRA, without you ever touching the money. If you get a check from your employer, you only get 80 percent; 20 percent will be mandatory withholding. You have to come up with 20 percent to make the rollover complete, and you have 60 days to do it. None of those rules apply if you do a trustee-to-trustee transfer. But then there's the other question of, if you don't know if an IRA rollover is the best option. This is not something to take lightly. When you're moving life savings, it's like an eggshell. If it cracks, it's over. If people do not move the money correctly (as a trustee-to-trustee transfer) it could be lost to withholding and tax, and many of these mistakes cannot be fixed.