IRA Rollovers and Roth IRAs

Sue Stevens finished her series of articles on IRAs and talked about Rollover IRAs and I learned something new! I had no idea that legislation was passed to allow people to take 401(k)s or 403(b)s and roll them directly into a Roth IRA- starting in 2008. I have 403(b) money in an old account and have pondered rolling it into an IRA and then converting that to a Roth, but that always seemed like a hassle- so I am interested to find out more about this. money

Basically if you have a 401(k) or 403(b) plan and leave the company you are contributing to the plan through, you usually have three options. money

1. Cash it out and pay penalties and taxes (don't do it).
2. Stop contributing, but leave it alone (some 401(k)s may not allow this)
   
3. Roll it into a rollover (traditional) IRA and as of 2008, into a rollover (Roth) IRA
   

The other thing she mentions is that IRAs and 401/3(kb)s have different dates at which you can begin to take money out without penalty. You can take penalty free distributions from a Traditional or Roth IRA at 59 1/2 but you may be able to make withdrawals from a 401(k) or 403(b) at age 55 if you no longer work at the company you funded the account through.

There are other factors to consider when making this decision- but direct to Roth rollovers and thinking about access before 59 1/2 are good issues to be aware of. money

Nice explanation of Traditional and Roth IRAs

Sue Stevens over at Morningstar has an easy to understand and very thorough overview of everything you should know about Roth IRAs. This includes more obscure options for claiming a loss, and good lists of how to make early withdrawals without penalty and without owing taxes. money

She also did an overview of traditional IRAs and is planning to do an overview of rollover IRAs.

IRA investing for 2006

When it comes to investing in my IRA every year, I procrastinate. So I am in the process of contributing for tax year 2006- you can contribute to an IRA up until tax day for that year- so I can contribute up to $4000 anytime before April 15th. Actually in Massachusetts, I have until the 17th because of the timing of patriots day. I am not sure how this works exactly- does your brokerage have to receive the deposit before the 15th/17th? Or does the deposit need to be initiated? Will my brokerage accept a deposit on Patriots Day? I am a procrastinator, but I am also too lazy to figure out the details so I will not wait until the last minute, I will contribute now and not worry about it. money

And while I procrastinate about pulling together the money to put into an IRA account, I do not put off investing the contribution since I am never going to build a sweet retirement for myself with all my retirement funds sitting in cash. money

Also, several people have asked me recently what I recommend investing in. I do not feel comfortable recommending specific investments for specific moments in time. So instead, I will share what I am planning to do. I do not recommend buying the same things I plan to buy since I am buying them specifically to balance against what I already own. But I feel good about all the holdings I am hanging on to after I rebalance and am happy to share my choices if it helps others learn about some of the options out there... money

I have more than one IRA and when I contribute each year, I try to look at them all at once to see what I am invested in and what to change to keep a diverse balance. I do this by copying all the holdings from each IRA into a spreadsheet and look up the current category for each holding on Morningstar, Here are the combined investments, organized by category and listing each specific holding and the overall percentage each holding represents: money


Three things stand out right away:

• Almost half of the investments are in large domestic companies
• There is very little invested in foreign companies
• I have several very small positions in a number of Janus mutual funds.

I also notice that most of my large domestic investments are in index tracking securities and everything outside of this category is in funds with managers trying to beat their respective indexes. money

So as I decide what to invest my 2006 contribution in, I aim to:

• Reduce my percentage investment in large US companies
• Increase my investments in overseas companies
• Clean up some of the clutter
• Diversify between index tracking securities and actively managed funds across more categories

This may sound complicated and expensive, but it really isn’t. Here is exactly what I aim to do:

• Sell my positions in JAGLX, JAGTX, JAMRX, and JAWWX (which has lagged its peers) to clean up the clutter.
• Add to my investment in JAGIX to add a little more active management to the investments in large US companies.
• Invest in VWO, EFA, and EFV all foreign index funds both increasing my international exposure and balancing against the actively managed foreign fund I already own.
• Invest in MIDSX to slightly increase my specialty interests.
• Invest in VBK, VB and VOE to increase my smaller company investments and again balance against the actively managed funds I already own.

Here is what my new IRA portfolio will look like:


Now I have more coverage of mid/small sized companies. I have managed funds and index funds, across many categories, No individual investment is smaller than 2% and the largest single position I have is 13% down from 15%. And I have more international and specialty coverage offering more diversity from the large US focus I had before. money

Also I am more diversified across fund companies. I think this is important because even when different funds at the same company focus on different sectors, it is often the same pool of analysts or same analyst strategy that is informing the various fund managers. Also, as companies struggle or do evil things, using a variety of companies reduces risk from these things as well. money

So now I have holdings from Janus, Vanguard, Fidelity, Artisan, T Rowe Price, iShares, Columbia, State Street Bank (they manage SPY), American Century, Wells Fargo, and Stratton and Boston Properties. money

All this diversity- across sectors (company size and growth vs value), strategies (index vs managed), and companies should mean that I am exposed to less risk in general but am still positioned to make gains if any for these sectors due well. money

So how much will it cost? All my IRAs are with etrade and have no account fees. All the mutual funds I am buying and selling are no-load, no-fee funds so no costs there either. My pricing for buying ETFs through etrade is $7.99 per transaction so the grand total I will pay is $47.94. I will post when I actually execute this plan. money

Saving for retirement vs saving for pre-retirement

Walter Updegrave at cnnmoney posted an excellent explanation of a good strategy for how to approach where to put your savings for retirement. And for those of us who work for non-profits, 403(b)s should be approached like he recommends approaching 401(k)s: contribute enough to earn your full employer's match (if any), fund a Roth IRA if you are eligible, then ad more to your 403(b). money

Combining this with the typical financial planning advice- "Pay off your credit card debt first" one can come up with a guide for how to manage one's finances, but it gets a little more complicated when faced with decisions about and how much to save in non-retirement accounts. (Not to mention what debt to pay off- Credit Card debt is obvious because the interest is usually high but College debt and Mortgages are worth exploring, but not in this post.) money

Walter says max out both your IRA and 401/3/k/b- and then contribute to a non-retirement account. To do this, however, you must be saving over $19,500 ($15,500+$4000). And he was addressing this to a married couple so they would have to save $39,000 a year before funding a non-retirement account. I do not believe Walter is really recommending this- he is trying to explain a way to think about retirement accounts that I agree with completely- Match your 401/3, then fund a Roth. But after that- at what point should you start saving for retirement? money

Let's face it, most of us want some wealth before we reach our 60s and I am betting that by the time I reach 60 the retirement age for social security at least, will be higher than it is now. money

So does it make sense to invest in a non-retirement account before maxing out your 401(k)? One thing to think about is how much retirement savings you have already and how much you are on track to have when you reach your 60s but lets look at the numbers. Say your employer matches 3% and you make around $40,000. That would mean you employer would match up to $1200 so you need to contribute that much to get the match. The maximum for an IRA is $4000, so you need to save $5200 to end up with $6400 in retirement savings for the year. money

Using CNN's savings calculator which uses a high rate of return at 9%- if you are 30 and save this much until 65, you will end up with $1,380,548.83. Before you get too excited, adjusted for an assumed 3% rate of inflation, that is only equal to $475,403.62 in today's dollars- hardly enough to cover 35 years of wild and crazy retirement adventures. money

But, if you contribute more each year, as you earn more and your employer matches more and IRA limits increase, you can make headway. (Notice I don't bother to include Social Security estimates- I'm a bit of a pessimist about that one). Regardless, you can use a simple calculator like this to put in your actual age and actual income and adjust the numbers to figure out how much you want to and can contribute to your retirement savings.

Lets assume for our example $5200 is enough and do-able. This comes out to about $433 per month. If you can save an additional $300 per month then you could buy three mutual funds and contribute $100 to each, every month and build up a nice non-retirement fund. Of course you will need to save up the initial minimum for each fun which for the funds we are looking at here range from $0 to $2500.

If the market does well and your Non-Retirment portfolio swells, you can tap into it to buy a home, a trip to Iceland, a diamond studded cell phone, start a charity, etc. before you turn 65. Maybe another way to think about it is: are the things you want to buy with your savings worth what you would need to do now to save that much... Saving $733 a month ends up being about $212 dollars per week.. Cancel cable, make your lunches at home and see if you can pull it off (or not if you decide you do not need that diamond studded cell phone after all). money

Social Security

In response to this article about the US going bankrupt, I commented on Social Security including crazy ideas like rolling back the retirement age and giving all my 'projected' payments away. money

I was discussing this with a friend over a frosty pint later on and he almost took his empty glass and wacked me over the head with it in a well-meaning attempt to knock some sense into me.

Anybody else want to buy me a pint o' cider and discuss? money