What is a Rollover IRA and do I need one?

Financial people and publications talk about Rollover IRAs or just Rollovers all the time—like everybody knows what they are. Yet, when you go to contribute to an IRA or other retirement accounts, rollovers are never one of your choices.

Bear in mind that rollovers can be made into various types of retirement accounts, not just IRAs. It’s just that rollover IRA accounts are frequently used because they can accommodate many other types of accounts.

Basic Primer on IRAs

So first let’s back up a little and talk about IRAs in general. Individual Retirement Arrangements (IRAs) are accounts you can use to set money aside for retirement. You can do these on your own, as opposed to many other types of retirement accounts that employers make available to employees.

IRAs come in essentially 3 types—traditional deductible IRAs, traditional non-deductible IRAs, and Roth IRAs. One of the main differences lies in the tax treatment of each. (Visit the IRS Web site for more information concerning IRAs.)

Traditional Deductible IRAs

Before Roths were invented, there were only traditional IRAs. They are still very much used today. With this type, you can contribute up to a given amount of money per year into your IRA account. Then, when you file your taxes for that year, you can deduct the amount you contributed on your tax return and not pay taxes on that amount.

Traditional Non-Deductible IRAs

Some people (or their spouses) are also covered by retirement plans where they work. Depending on how much they make (a calculation called Modified Adjusted Gross Income), they may not be able to deduct any of their IRA contribution, or they may be able to deduct only part of it. They can still contribute up to their given limit, but they can’t deduct any non-deductible portion on their tax return.

You might wonder who would want to do that, to contribute to an IRA but not be able to deduct the contribution. Well, your money is still allowed to grow tax-deferred. Once it’s inside the traditional IRA, whether you deducted the contribution or not, you don’t pay taxes on it until you take it out.

Roth IRAs

Roth IRAs have different tax features from traditional IRAs. You are not allowed to deduct your contributions to a Roth IRA. Whatever you contribute, you go ahead and pay taxes on that amount. However, when you take your money out of a Roth IRA, if it’s done in accordance with the rules, you will owe zero taxes on what you take out. However, in the years that your Modified Adjusted Gross Income is too high, you may not be eligible to contribute anything to your Roth IRA account, or you may be able to contribute only a reduced amount.

So what about Rollovers?

Rollovers come into play when you need to switch your money out of one retirement account and into another. Typically, you don’t want the money to come straight to you because of the taxes and penalty that can be triggered, and also because you might spend it

Say you’re changing jobs and you need to do something with your retirement account. (Sometimes you may be allowed to leave you money in the old plan, but even if you can, you may or may not want to do that.) If the money gets distributed directly to you and you don’t get it back into a qualified account within 60 days, you’ll owe taxes on it and possibly an additional 10% penalty. This is where a rollover account comes into play to avoid this tax and/or penalty issue:

1. Direct rollover—you establish another retirement account with perhaps a mutual fund company, brokerage firm, bank, or your new employer’s plan. Then you request the plan administrator from your old plan to transfer the funds directly to your new account or to make a check payable to your new account and not to you directly. No taxes will be withheld from your transfer amount.

2. Trustee-to-trustee transfer—perhaps you have an IRA and want to change the institution that’s holding it. You go open another IRA with the new institution and then ask that your funds be transferred directly from the old institution to the new. Again, no taxes will be withheld from your transfer amount.

3. 60-day rollover—sometimes your old plan doesn’t give you a choice and pays the money in your retirement account or IRA directly to you. You have 60 days to deposit the money in a new qualified account without having to pay taxes, but there is a catch with this option. Your old retirement plan administrator will withhold 20% to apply toward taxes. In order for you to get the entire amount into the new account, you’ll have to come up other funds out of pocket to make up for the 20% withheld. Then when you file taxes for that year, you can get your money back. Ideally, you wouldn’t choose this option if either of the other two options are available to you.

Rollovers of Retirement Plan and IRA Distributions

All that money you’ve been setting aside will come in handy, once you reach retirement. That’s when a rollover of your funds will come in handy as well. While Rollover IRAs are popular, the type of rollover that’s appropriate for you will depend on the type of existing account your have. Not all retirement accounts are compatible, just like you can’t mix oil and water. Click on this Rollover Chart from the IRS which shows the allowable rollover transactions.

Say that you’ve reached retirement day and are ready to start making withdrawals. You may not be allowed to leave your money in your previous employer’s account. Or you may desire other investment options than what are available to you presently. You pick where you want your money to go and set up the appropriate rollover account with them. Then you have your funds transferred over to your new account using one of the three methods listed above. With rollover accounts, you’re allowed to transfer over the entire amount, although there are some exceptions. You’re not limited to the yearly contribution amount.

You’ll want to learn everything that applies to your situation and your account before you initiate a rollover. You want to avoid paying taxes and penalties! Consult your existing and future account administrators and your tax professional. Be sure to visit the IRS Web site concerning Rollovers for more information.

Here’s my disclaimer: I am NOT a tax professional, and this article is for general informational purposes only. It may or may not be the information you need for your situation. Very little about taxes is simple or straight forward. There are all sorts of exceptions. Retirement plans can vary in type and in how they are set up with the employer. You should always seek out competent professionals who know about your specific retirement plan and your specific situation.

You can find more information on retirement accounts as well as other personal finance topics in my book, Money For Life. It’s available on Amazon as either a paperback or an e-book download for Kindle. [Note: you do NOT need a Kindle to read it. Amazon has a free reader download that allows you to read Kindle books on your computer.]

Finding Work You Love!

Is that even possible? Can you really enjoy what you do and look forward to going to work every day? Absolutely, but you may need to do a little soul searching first.

“Most Americans evaluate their lives in retrospect, having no clear sense of control, purpose or destiny for their future.” That’s what Dan Miller, author of  48 Days to the Work You Love has observed after having provided career counseling to thousands. Here’s just a snippet of the many statements he’s received:

• 51-year old businessman—I feel like I’ve lived my whole life by accident.

• Salesman—I feel like I’m a ball in a pinball machine.

• 56-year old man with PhD currently driving a bus—I feel like I’ve been given six seconds to sing, and I’m singing the wrong song.

• 39-year-old automotive engineer—I’m a butterfly caught in a spider’s web, with my life slowly being sucked out.

Ouch! Those are truly painful statements, and worse, a huge waste of human potential!

If I had all the money I needed and there were no obstacles in my way, what would I be doing?

No, that’s not a trick question, but it is a good place to start in finding work you love. And the answer is not sitting on the beach or playing golf or [fill in the blank] for the rest of your life, because after a few months you’d be bored out of your skull. As one of my friends who had health problems and retired early stated after only a month or so of leisure—“Oh, to have meaningful work again!”

What are the things I can do skillfully and with ease?

So after you’ve made a list of what you would love to be doing, make another list. This time take an inventory of all the things you do well, your talents, skills and abilities. Don’t underestimate yourself and don’t be modest in your assessments. “Soft” skills often get downplayed, so if, for example, you’re usually able to defuse tense situations, give yourself credit for being a peacemaker and recognize it for the valuable skill that it is.

Search for your sweet spot—where your abilities unite with your passion.

Now, with your two lists in hand, it’s time to start marking through items that are not a good fit for you. Things that you have an interest in but not the ability to do well get crossed off your first list. Perhaps you love playing the piano but have difficulty getting your fingers on both hands to work at the same time. You know that’s not ever going to be your forte.

On your second list, go down the line and look for things that make you roll your eyes. Those are the things you’re qualified to do, but you either dread doing or they bore you to tears. Definitely mark through those, as they’re clearly not in your passion zone!

What’s left on your two lists?

Ideally, there’ll be some things that didn’t get marked off your lists. These represent your best candidates for finding work that you’re both interested in doing and that you possess the skills and ability to do well. It may not be feasible for you to jump into a new line of work just yet, but now you know more about how to direct your future efforts. Just as importantly, you’ll know what areas you don’t want to develop further.

Use your time off to reassess your line of work.

If you happen to be between jobs, this could be a great time to reevaluate what you really want to do. Finding meaningful work that you are passionate about and that plays to your strengths and abilities is like discovering what you were meant to do in life. Make it your mission to find this sweet spot. After all, this is your life, and you may as well enjoy it!

Change Your Life in 31 Minutes

Special thanks to my guest blogger, Derek C. Olsen for this great article. I predicted his book, The Four Week Financial Turnaround, would soon become a bestseller, and I was right! Yes, it’s that good! If you’re ready to stop complaining about your money and take action, Derek shows you how to make real changes happen. And you can start with the next 31 minutes!

Change? Yes, please.

You are here, and you want to be there. Change is the only thing that will get you there.

Join me in spending just 31 minutes pondering your current and future financial situation. A minute-by-minute Q & A that will change your financial life. Be brave and literally write down your answers. Then write down your goals and action steps. Then, take action. Change is waiting.

Ready, Set, CHANGE!

Minutes 0-4

• Ponder where you are now. What does your current situation look and feel like? Use descriptive words like comfortable, dangerous, unsteady, or acceptable. Do you have all your financial bases covered? Which areas are well taken care of, and what needs attention?
• Example: I feel overwhelmed by my my garden variety consumer debt. I make plenty of money, but I am unorganized and don’t have a plan. I don’t know where to start.

Minutes 5-9

• Ponder where you want to be. Imagine the place you want to be and then describe it. Again, use descriptive words like secure, confident, independent, and organized. Why do you want these things and what will they allow you to do, be, or have?
• Example: I would like to be organized, on a debt payment plan, and debt free by the end of 2014. This will allow me to give more to the needy, have less stress, and I just might buy myself something nice, too!

Minutes 10-14

• Identify what isn’t working. What are you doing that isn’t working well? You must start this section believing that change is possible.
• Example: I know I can do this, if I just quit ignoring my debt and really get serious about paying it off I can become debt free in less than two years. I need to stop winging it each month. My current plan isn’t working as well as it could be.

Minutes 15-19

• Create a new plan that will work better. With all the options out there, there must be something that will work better. Something that you can replace those parts that aren’t working well with.
• Example: I need to start a monthly budget and create a debt payment plan. This will include cutting back on clothes and restaurants for two years. If I redirect $240 more dollars a month to my debts, I will be debt free in two years.

Minutes 20 – 24

• Commit to taking action. Don’t give up, make adjustments as needed. Chances are, like with anything new, it will take some readjustments to get it just right. Did you tie your shoes correctly on the first try? Did you hop on a bike and take it for a spin around the block on the first try? Realize from the beginning that you will make mistakes, experience setbacks, and will need to do something over.
• Example: I am tired of my current situation and slow progress. Two years will pass anyway. I know I can do this and it won’t even be that difficult. I am thrilled at the opportunity to make real, lasting change. I will stick to my plan even when I experience temporary setbacks and even if I drop the ball every now and then. I don’t expect to be perfect, but I do expect to reach my goal.

Minutes 25 – 30

• Be brave and literally write down your answers. Then write down your goals and action steps. Then, take action. Change is waiting.
• Get up, right now, and take the first step.
• Example: No time for an example, I am off organizing my debts…

What changes would you like to make? What has or has not worked for you when chasing goals and making changes? Be sure to let Derek know. You can find him over at his new site How Do I Money?  He also has a podcast and other cool stuff you can check out there!

Unique Features of the Roth IRA

The Roth IRA—It’s a Gem of a Financial Planning Tool!

Financial planners and estate planners alike love the Roth IRA, and for good reason—there’s nothing else like it.

So what makes the Roth IRA so special? While this retirement account has a number of great features, here are 3 of its most attractive:

1. Tax-free Withdrawals

If you qualify to contribute to either the traditional deductible IRA or the Roth IRA, which should you do? If you contribute to the traditional deductible IRA, you can deduct your contribution amount (up to your allowable maximum) and lower your taxes for the current year. On the other hand, with the Roth you don’t get the current tax break. But your reward is on the other end—zero income taxes on qualified withdrawals! The tax break you forego today could be quite small in comparison with the potential future benefit. The larger your account grows through the years, the greater the benefit of a Roth.

2. Flexibility

Additionally, a Roth offers a great deal of flexibility during your working years. If you must make an early withdrawal after your money has been in your Roth for at least 5 years, then the first dollars out are considered return of your contributions. Since you have already paid taxes on your contributions, no income taxes are due unless you withdraw more than you contributed. In that case, taxes would be due on the growth portion.
If your money has not been in at least 5 years, then early withdrawals could be subject to a 10% penalty (but there are some exceptions). Bear in mind, you would not want to take an early withdrawal from any retirement account except in an extreme emergency. Withdrawing the money means it’s no longer growing in your account, and you can only contribute the yearly amount allowable. Say you take out $10,000 for some reason. You can’t just go stick the $10,000 back in. The most you can put back in is $5,500 (as of 2017; $6,500 if you’re 50 or older).

3. Advantages in both retirement and in estate planning

When you retire, if you don’t need the money from your Roth you can leave it invested because you are not required to start taking minimum distributions (RMDs) from a Roth IRA. Then, when your loved ones receive the Roth at your death, they do not have to pay income taxes on the money either, unlike money from other inherited retirement plans.¹ So the Roth can serve as an excellent estate planning tool, helping you maximize the wealth you pass on to your heirs.

¹ Income taxes are a separate issue from estate and inheritance taxes, which could still apply, depending on the size of the taxable estate and the state in which you live.

Note:  Few things regarding taxes are simple and straightforward. There are many exceptions to seemingly every rule. For more information on Roth IRAs, refer to www.rothira.com or the IRS site, https://www.irs.gov/retirement-plans/roth-iras. If you prepare your own tax return, a tax preparation program is quite helpful because it asks you a series of questions to help determine if certain exceptions or limits or situations apply to you.

You can find more information on the Roth IRA as well as other personal finance topics in my book, Money For Life. It’s available on Amazon as either a paperback or an e-book download for Kindle. [Note: you do NOT need a Kindle to read it. Amazon has a free reader download that allows you to read Kindle books on your computer.]

5 Reasons to Keep Cash Value Life Insurance

Before canceling any life insurance policy, examine ALL its features first!

• Do you already have life insurance that builds up savings, or cash value?

• Are you thinking about surrendering your policy and getting term insurance instead?

• Before you do, here are some things you’ll want to consider.

Term Insurance Can Be the Best Choice. . . .

Financial advisors often sing the praises of term life insurance, and with good reason. For many people, it’s truly their best choice. Take, for example, a young family with small children and a limited budget. Term insurance often provides a cost effective way to supply them with the large amount of insurance money they need. Should one of the parents die early, it will be many years before the kids are grown and through college. The surviving parent needs a lot of dough to help with all that, and term insurance is almost always their best choice.

But Not for Everyone!

But one-size-fits-all rules are like those big, sloppy t-shirts: they fit a few people well, many people poorly, and some people not at all. Depending on your circumstances, term insurance may NOT be the best fit for you. In particular, if you already have a policy which builds cash value, you need to think long and hard before surrendering it.

Cash Value—What is it?

Life insurance either builds cash value or it doesn’t. Term life insurance does NOT. It has only one component—protection. You buy it for a given term, or period of time. If you die during that term, your beneficiaries get the pay out, or proceeds. If you don’t die, your reward is that you’re still alive, and that’s it. There’s no residual—no savings, no investment.

Life insurance that DOES build cash value comes in many variations, such as whole life, variable life and universal life. These type policies have two components: protection (the pay out your beneficiaries receive if you die) and savings. How quickly the savings portion builds up and what it’s invested in can vary widely, depending on the structure of your policy.

Why NOT buy cash value life insurance?

Building up savings sounds like a good idea. So why is it that financial advisors tend not to recommend these type policies? For one thing, they can be complex—hard to understand, and even harder to evaluate. You may not know what you’re actually getting, and worse, neither may the agent who’s selling the policy.

For another, the rate of return on your savings or investment can be quite low compared to what you could be getting elsewhere. If you can afford the higher premiums that usually accompany cash value policies, advisors often suggest you buy lower cost term insurance and invest the difference in the payments in higher performing investments.

Should you keep your existing cash value policy?

However, like those t-shirts, cash value life insurance can be appropriate for some people. And, if you already have such a policy, here are some questions for you to consider before giving it up:

1. Where are you NOW in the schedule for how the cash value builds up? Most of these policies build very little savings at first, but you may already be past those low buildup years. What you’ve already given up is gone, regardless of whether you decide to keep this policy or buy another. So all that matters now is how your cash builds up from this point forward, and if it is building up, you may want to keep the policy.

2. Have you developed health issues since you purchased your policy? If so, you may never want to surrender your policy, particularly if your premiums remain constant through the years. It can be quite difficult, not to mention expensive, to get any type of new policy once certain health problems are discovered.

3. What is your age? Unfortunately, the older you get, the more likely you are to pass away during a given time period. So the older you are, the higher the premiums, and term insurance may no longer be the bargain for you that it is for younger people. Worse, the increase in term premiums tends to take much bigger jumps each time you renew your policy.

4. What is your tolerance for risk? Risk and return are positively related. That means if you want a higher return on an investment, you’ll probably have to take on a higher risk to get it. The higher the risk, the greater the possibility you’ll lose money as well as gain money. So, if risk is difficult for you to stomach, the low but guaranteed return which some of these policies offer may be extra appealing to you. But remember, any guarantee is only as good as the company that stands behind it. Make sure you go with a large, financially sound company that consistently delivers on its promises.

5. Are you in a higher tax bracket? The savings portion of a cash value policy is allowed to grow on a tax-free basis. This feature becomes more attractive to people who are in higher tax brackets. Take, for example, someone whose marginal tax rate is at 50% versus someone who pays at 15%. (Remember, you must consider the total taxes that apply—federal, state, local, etc.) If a cash value policy earns at 4%, the person who is taxed at 50% would have to earn 8% on a regular taxable investment to be left with 4% after paying taxes. The person who’s taxed at 15% has to earn only 4.7% to be left with the same 4% after taxes. That means the higher the tax rate that applies to your regular taxable investments, the higher the risk you must take in order to be left with what you could earn on a tax free basis.

If you decide to surrender your policy—

After you’ve considered all the angles and decide that, yes, you want to quit your existing cash value policy, don’t leave yourself unprotected. Get the replacement policy up and running before you cancel an existing policy. If you leave a gap in your coverage, something could go wrong—like the premiums may be much higher than anticipated due to a health issue uncovered in your physical exam, or you could get hit by a freight train, or whatever. You get the idea.

Also, you need to formally cancel your policy and not just quit paying the premiums. If any cash has already built up in the policy, you want it refunded to you. Otherwise, if you don’t follow the company’s rules for canceling, they are likely to use up your cash value paying your premiums on your behalf until it’s all gone before they actually cancel your policy.

You can find more information on life insurance as well as other personal finance topics in my book, Money For Life. It’s available on Amazon as either a paperback or an e-book download for Kindle. [Note: you do NOT need a Kindle to read it. Amazon has a free reader download that allows you to read Kindle books on your computer.]