Everything I wanted to know about Individual Retirement Accounts

"An IRA is a tax-advantaged investment account individuals can use to save for retirement. Unlike a 401(k) or 403(b) plan, which is employer-sponsored, IRAs let you set aside money on your own, which can be beneficial for individuals who are self-employed or have employers who don’t offer a 401(k) or another retirement plan." - JPMC Blog Post

An IRA is an investment account focused on building a retirement fund (sometimes referred to as a "nest egg"). If you have the guts and know-how, you can choose to pilot it yourself, but banks, credit unions, etc., will sell their management services to you alongside the account. In my opinion, I think it's an arrangement worth whatever fee is charged: it is in the financial institution's best interest to cook up the best retirement package and occasionally tweak it for you so both of you get paid, it's a load off your mind, and you can learn from your financial advisor/institution over time.

IRAs have income requirements but if you're actively looking to open up a IRA versus, for example, being content with your employer's 401(k), you likely already meet the requirements for one.

Since IRAs are investment accounts, they're made up of stocks, bonds, investments in mutual funds, and so on.

Since it's your account, you get to put money in it (duh), but there are yearly limits to contribution like with 401(k)s.

Types of IRAs

Technically, there are four types of IRAs:

Traditional
Roth
SEP
SIMPLE

SEP and SIMPLE are both acronyms; the former stands for Simplified Employee Pension (like the old days), the latter stands for Savings Incentive Match Plan for Employees. These are IRAs for both the self-employed and for small to midsize businesses.

Most people are concerned with the Traditional and Roth IRAs. If you switch between jobs (i.e., layoffs, moving to new positions), you'll likely have your 401(k) from your prior employer floating around slowly earning cash. With how crazy life gets, it's easier than you think to lose track of some rogue 401(k) you had. Centralize those 401(k)s with a IRA; it's what I did when I was part of the COVID layoffs.

Traditional IRA

TODO: pluck info out of the Investopedia article on Traditional IRAs

Most young earning adults not coming from privileged households should choose a traditional IRA. Traditional IRAs empower early contributions: whenever you make a contribution to a Traditional IRA, the money you put in is not taxed on deposit.

That money, spread out across the IRA's investments, grows in a tax-deferred state and is not taxed until the account owner is either old enough to start withdrawing from it or certain conditions allow the owner to withdraw a portion: "[t]he IRS assesses no capital gains or dividend income taxes until the beneficiary makes a withdrawal". Additionally, if you make annual contributions to your traditional IRA, they can be used as tax deductions for that year's income taxes.

When you're finally of age to start withdrawing from the traditional IRA at 59 and a half years old, you are obligated to take a Required Minimum Distribution once you reach 73. This means you must withdraw a sum of money designated by the IRS, and this payout may change your tax bracket during your more vulnerable senior years. To help alleviate this, financial institutions came up with the...

Roth IRA

TODO: pluck info out of the Investopedia article on Roth IRAs

TODO: add info on the Roth IRA 5-Year Rule (Investopedia)

Adults facing retirement in the next decade or so, or those who have had high income from the jump may opt for a Roth IRA. A Roth IRA is an inverse Traditional where all contributions are taxed, contributions are not tax deductible, and all withdrawals are tax-free. Roth IRAs also have no Required Minimum Distribution.

If your income exceeds a certain threshold, you will not be allowed to make contributions directly to a Roth IRA. However, it's perfectly legal to convert a Traditional IRA to a Roth IRA, which is a vehicle for indirectly contributing to a Roth IRA. This is a common enough play that the IRS is well aware of it and asks you to pay a tax on that conversion.

Timing and implications of Traditional to Roth IRA conversion

Sourced from this JPMC blog post on Traditional vs Roth IRAs:

Tax implications

Depending on the amount you choose to convert and your tax bracket, converting to a Roth IRA may result in a hefty tax bill the year you convert. This is because converting from a traditional IRA to a Roth IRA will generally mean you have to pay taxes at ordinary income rates on the amount converted in the year you do this. Once you convert, your contributions are made with after-tax dollars, however “qualified distributions” (as defined by the Internal Revenue Service) will be tax-free.

If you expect to be in a higher tax bracket in retirement, converting earlier rather than later and getting the tax payments over with may result in savings. So do the math: Compare the immediate tax bill from converting now (and the potential lost earnings on that tax bill) versus the projected overall income tax bill you’ll get once you are required to begin withdrawing in the future.

Also, consider how you’ll be paying the tax bill that will result from converting a traditional IRA. If you choose to use part of the converted amount for this, less money will be available to take advantage of the tax-free growth offered by a Roth IRA account. In addition, using converted funds to pay the tax bill could trigger a 10% early withdrawal penalty. The tax and penalty together, along with the lost earnings on these amounts, could end up costing you more than what you’ll save from future tax-free withdrawals. So again, it’s important to do the math and consider talking with a tax professional.

If you don’t convert, you’ll be required to withdraw regularly from your traditional IRA after you reach a certain age, and you’ll generally pay taxes on most of those required distributions (and most other withdrawals).

Timing

The “when” of the conversion can potentially cost or save you on taxes. So timing is everything.

For instance, if you know you will be moving from a low-tax state to a higher-tax state, it may make sense to convert your traditional IRA to a Roth IRA while you are paying taxes in the lower-income tax state.

If you don’t convert and you relocate to a higher-tax state, you may have to take distributions (or convert) in a higher-tax state and pay more in state income taxes.

If unforeseen circumstances leave you without a job for a while, this may push you to a lower tax bracket. Switching to a Roth IRA during this period may help decrease your tax bill at conversion before you move back into a higher bracket.

Charitable giving

If your long-term goals include giving to charity, a traditional IRA may be a better choice for tax purposes. Those with a traditional IRA can distribute up to $108,000 to charity tax-free each year starting at age 70 ½ as of 2025.3

With this in mind, converting – and paying that big tax bill – may not make sense if your plan is to donate funds in your IRA to a nonprofit.

There are many variables to consider before taking action, so consider talking to a financial advisor and a tax professional to ensure you think through all of them.

Funding your IRA

As mentioned earlier, I worked with my financial advisor at my bank to roll over my 401(k) during COVID. We contacted my 401(k) provider, they had me confirm my identity, had my financial advisor confirm where the money was going, and they sent me a check that my financial advisor processed for me.

JPMC has another blog post about rolling over 401(k)s and some considerations to make:

https://www.chase.com/personal/investments/learning-and-insights/article/rollover-401k-to-ira