Ask-A-Planner Mailbag

Many friends of Financial Finesse and readers of our daily blogs send us direct questions and various inquiries through our social media sites. Occasionally we will highlight some of the more frequently asked questions and provide you with a summary response.  In this version of the Ask-A-Planner mailbag, we will examine a couple of questions regarding Individual Retirement Accounts.  To help examine these questions, I thought I’d turn to Paul Wannemacher, one of our resident financial planners and a recent addition to the Think Tank at Financial Finesse, for some guidance. 

Should I consolidate my IRAs into one financial institution?

In general, if you are satisfied that you have one IRA custodian whose services you like best and you feel your service pricing is fair, then sure, it can make sense to consolidate your IRAs into one place.  Almost all permissible IRA investments like mutual funds, stocks, bonds, etc. are transferrable between custodians so you can hold different “brand names” in one account.  So you can reduce mailbox clutter and avoid having an IRA “orphan” that gets lost in the shuffle if you consolidate. 

IRA custodians also sometimes offer incentives for additional deposits like a block of free trades or a rebate.  Check with your IRA provider before you consolidate to determine if any costs for transfers apply or if the investments you want to transfer are allowed to be held in your new primary IRA.  If you have costs or issues with this, it might be worth looking for an IRA provider who can house everything at the least cost.  A link to compare the larger online IRA providers is as follows: http://www.stockbrokers.com/compare

However, there are circumstances where the consolidation might not be the best idea.  If you have 401(k) balances at a former employer that allow you to keep them there, you might have lower management costs overall at the 401(k) versus the new IRA provider.  The 401(k) rollover process usually involves the transfer of your balance as a “cashed out” transfer, meaning a check or wire goes to your IRA and you re-buy your investments there – a new cost you may not have anticipated.  Some intrepid investors have self-directed IRAs that have non-standard investments such as real estate holdings or commodities that require a specialist IRA custodian.  In that case, consolidation may not be possible.  Also, make sure you don’t mix your traditional IRAs and rollover IRAs from a previous employer unless you’re sure you won’t want to ever transfer the consolidated IRA to a new employer’s plan later.

What is an IRA rollover and how does it work?

Am I better off with a ROTH IRA and if so, why?

Both a traditional-type IRA and the Roth IRA can play a part in your future savings plans.  In the short run, a traditional IRA has an up-front benefit – some or all of the savings contributed may create a tax deduction benefit for you. So, if your current tax bracket is high enough that you want to reduce taxes, contributing to a traditional IRA (or 401K-type plan at work) will be attractive.  The growth will accumulate tax-deferred (not tax-free) until you pull it out, presumably when your income is less and you need the IRA to support your retirement.  It will be taxed as income regardless of whether the growth comes from interest, dividends or capital gains.

A Roth IRA might seem a little harder to add to up front – you do so from post-tax funds and don’t get a tax deduction.  But it has a big future benefit – if you can wait to access the earnings until after age 59 ½ and keep it in place 5 years, those earnings will be tax-FREE, not tax deferred.  The contributions (or basis) themselves are available anytime without tax or penalty.  Tax-free is always easy to like and creates the largest net benefit. 

So…if you’re in a lower tax bracket now and the deduction for a traditional IRA or 401(k) contribution won’t affect your taxes much, consider adding to a Roth IRA or Roth 401(k) first.  The benefit will really show later, especially as your income increases later in life.  It’s also the best asset to pass to beneficiaries if you don’t use it all – they get the tax free growth as well until they are required to pull it out, possibly a long time from now!

How do you decide which type of IRA to invest in?

Special thanks to Paul for his assistance in tackling these questions! Do you have any specific questions to add to the Ask a Planner mailbag?  If you’re interested in having a question addressed on our blog, you can enter it in the comments section below.

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