Should they be saving with a roth ira or a

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Should they be saving with a Roth IRA or a traditional IRA? A: This taxpayer should be saving with a Roth IRA because they are expecting to have a higher tax rate in retirement. IRA Rollovers A "rollover" occurs when a retirement savings instrument, like a 401(k), from a previous employer is transferred into an IRA. This commonly occurs when an employee either retires or otherwise leaves a company. If an employee elects for a lump sum distribution but they do not want to incur a substantial amount of taxable income, then they can roll the lump sum into an IRA. Roth 401(k)s, Roth 403(b)s, and non-deductible IRA contributions can all be rolled into a Roth IRA. All other retirement plan types (i.e. 401(k)s, Profit-Sharing Plans, Money Purchase Plans, etc.) must be rolled into a traditional IRA. A direct rollover is the best way to conduct this transfer. With a direct rollover, the assets are transferred from the custodian of the 401(k) (or other retirement savings instrument) directly to the custodian of the IRA. The taxpayer could roll into an existing IRA or they could create a new IRA. If a direct rollover is chosen, the money must be deposited into the new custodian’s IRA account no longer than 60 days after the funds leave the 401(k) custodian. This is generally not a problem in a world with electronic money transfers. The IRS imposes this restriction to prevent any funny business. An indirect rollover is a hassle and is only generally done by those who do not know any better. With an indirect rollover, the taxpayer acts as a middle man in the transfer. The 401(k) custodian sends a check to the taxpayer who then sends a check to the new IRA custodian. If the check is made payable to the new IRA custodian and the taxpayer merely forwards the check, then this is really just a very inefficient direct rollover. The problem occurs when the check is made payable to the taxpayer themselves. In this case, the 401(k) custodian is required to withhold 20% from the amount of the taxpayer's account and send it to the government for income tax withholding. The assumption here is that the taxpayer is receiving a lump sum and not rolling over into a tax-sheltered IRA. The taxpayer will get the money back from the government when they file their taxes (assuming they did forward the other money to the new IRA). The real problem is that in order to avoid taxation and possibly early withdrawal penalties, the taxpayer must come up with whatever amount was forwarded to the government out-of-pocket. Consider two taxpayers, both of which are in their 40s. Taxpayer A elects a direct rollover of his $100,000 401(k) into his traditional IRA when he switches jobs. The 401(k) custodian will send the money electronically to the new IRA custodian and send the taxpayer a 1099-R form with a distribution code that shows the amount was a direct rollover. The new IRA will send the taxpayer a 5498 form as a tax receipt of the contribution received. Easy. However, Taxpayer B mistakenly elects an indirect rollover in his $100,000 401(k). His 401(k) company will mail him a check made payable directly to him for $80,000.
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