Archives For IRAs

A friend of mine gave me her 401(k) information to look at. Her company changed 401(k) providers and went with Nationwide. I wasn’t fond of their previous 401(k) provider (I forget the name now), so I was happy to see a change.

I flipped through the information packet and landed on the page listing their options. I was pleased to see companies like DFA, Vanguard, American Century, etc. Expense ratios for the funds were fairly low too (the highest was 1.21% for a SmallCap value fund).

Then I turned the page…

IN ADDITION to the mutual fund expenses, Nationwide tacked on an additional annual management fee ranging from 1.02% to 1.27%.

So…the Vanguard Index 500 Signal Class, with a .05% management fee, now had a 1.32% annual fee! FOR AN INDEX FUND!!!!!

Now, I know why companies do this. Small companies are struggling. Health insurance premiums are going up. Gas is expensive. So, a broker or advisor comes along and offers a 401(k) plan that is really cheap to the business owner and the costs to the employees are either glossed over or buried in the information. Sadly, most employees don’t have a clue.

To give you an idea of the impact of a 1.27% additional fee, I ran some numbers. I assumed an employee socking away $10,000 per year in the S&P 500. Using monthly returns, I calculated that at the end of 10 years (2003 – 2012), the 1.27% annual fee would have lead to a loss of $8,800 to fees (you can see my numbers here). That’s a sizable chunk of change.

My advice would be to only invest enough to get any company match and then max out a Roth IRA (assuming you qualify) or a traditional non-deductible IRA. There is no sense in throwing away money due to useless fees.

Where does it stop?

Obama budget to take aim at wealthy IRAs

From the article:

Under the plan, a taxpayer’s tax-preferred retirement account, like an IRA, could not finance more than $205,000 per year of retirement – or right around $3 million this year.

I’ll look more into this later.

I’m in the process of reading John Bledsoe’s The Gospel of Roth: The Good News About Roth IRA Conversions and How They Can Make You Money
*. So far it’s a great read. As you can probably imagine, Bledsoe is sold on the Roth IRA. Reading his book, I couldn’t help but daydream about what it would be like to have $1,000,000 sitting in a couple of Roth IRAs ($500,000 in each) by the time my wife and I retire.

Then I got to thinking…

How long would it take to get to $1,000,000 in a Roth IRA(s) if I contributed the maximum amount each year to two IRAs?

The maximum contribution amount is currently $5,000 per person ($6,000 per person if you are over 50). Due to silly income restraints, I would have to first contribute to a nondeductible IRA and then convert it to a Roth IRA. Either that, or I could make Roth contributions through my wife’s 401(k).

Here is what the math looks like:

As I noted at the bottom of the graphic, the $1,000,000 goal is not adjusted for inflation.

How long will it take?


If this little exercise tells us anything, it’s that it’s best to start working towards financial goals AS SOON AS POSSIBLE. If you don’t, you are faced with either having to SAVE MORE or reach for higher rates of return (gamble).

*Affiliate Link

I listened in on a Roth IRA Converstion conference call with a Charles Schwab representative this morning. offers a pretty nice resource for Roth IRAs.

In 15 days an opportunity will become available that will allow people at all income levels to convert a non-deductible IRA to a Roth IRA. Previously, that option was only available to those with modified AGIs of less than $100,000.

As the host of the conference call mentioned, there are definitely some things to think about before making the conversion:

1. Will you be in the same or higher tax bracket in the future when you begin making withdrawals? Of course none of us know what tax rates will be like in the future but I would have to say that they will be HIGHER. Factor in required minimum distributions (RMDs) from taxable plans (there are no RMDs with a Roth IRA) and you might be moved to a higher income tax bracket.

2. Do you have a long time-horizon? The longer the time horizon, the better. You have to factor in the opportunity cost of paying taxes now in order to receive tax-free income in the future.

3. Can you pay the tax on the conversion from sources outside the IRA? You’ll receive little benefit if you have to pull money out of the IRA to pay the income taxes on the conversion.

4. How will the conversion affect your AMT (if you’re subject to the AMT)? A good tax program like TurboTax or Tax Cut will help you walk through those scenarios.

5. Would you use the Roth as an opportunity to pass on assets to your heirs? If this is the case, then other issues may not be of importance to you.

One other thing that is significant about 2010 is that if you make the conversion in 2010, you’ll have the opportunity to have the conversion amount added to your income in equal amounts over the 2011 and 2012 tax years. For instance, say you convert an IRA to Roth IRA and the taxable amount is $50,000. You will be able to have $25,000 added to your income in 2011 and 2012. Of course, something to keep in mind is whether or not you’ll be in a higher tax bracket in those years and whether or not the conversion amount will throw you into a higher bracket.

Lot’s of stuff to consider.

If you have any questions, feel free to leave a comment. I’ll see if I can get the Schwab rep to answer them for you. In the meantime, check out Schwab’s Roth resource. Another helpful resource is IRS Publication 590 (PDF).

My Charles Schwab friend sent me the following email (adjusted slightly because I received it two days ago).



Two countdowns, one problem: Nobody knows about them.

1. In 73 days, the 2010 Roth conversion opportunity will go into effect, allowing people earning over $100,000 to convert to a Roth IRA and enjoy tax breaks down the line.

2. In just 1 day, on October 15, we reach the deadline for Roth conversion take-backs: if you already switched to a Roth in 2008, you can undo the move (“recharacterize”) and convert your Roth IRA back to a traditional IRA, shrinking your overall tax bill and returning taxes paid with interest.

Schwab’s latest survey found that those most impacted by the 2010 change…

• don’t know about the 2010 Roth conversion rule changes (61 percent),

• are confused about the rules (26 percent find it more confusing than health reform),

• are not planning to convert (72 percent).

I kind of fell down on the job on this recharacterization stuff. For those of you who aren’t sure about recharacterization, it’s the process of reversing the conversion of a traditional IRA to a Roth IRA. I was going to explain the process in a post but I really can’t do a better job than was done in this article.

Check out this quote from a recent Wall Street Journal article by Andrea Coombes:

…about 40% of workers in their 20s and 30s said they had cashed out their 401(k)s or 403(b)s when they switched jobs, according to an online survey of about 1,200 people conducted in January for Fidelity Investments by CMI, a research firm.

Quiz time:

You quit your job and take a new job with a different company. You have $800 in your old company’s 401(k) plan (you had just started contributing). Do you:

1. Move the money to your new company’s 401(k) plan?
2. Move it to an IRA?
3. Cash it out because it’s such a small amount of money?

Of course options 1 and 2 are the best. Number 3 is the worst. But, how bad is it?

Well, for starters, your employer will have to withhold 20% of your $800 for income taxes. You will also lose another 10% due to the IRS’s early withdrawal penalty. So, your $800 becomes $560 by the time you actually receive it.

Now, what’s the opportunity cost for cashing out your 401(k)? As you can see from the following graphic, it can be a significant amount over a long period of time:

Don’t underestimate the potential growth of a small amount of money! Instead of looking at $800 as a small amount of money now, consider it’s future value if invested properly. And, if there’s ever a time when you are tempted to cash out your 401(k) in order to pay bills, fix your car, or take a vacation, PLEASE re-read this post!

Here’s an email I received this morning from a reader:

Silly me…..I have been reading your column and never thought to ask you a question!! I love reading your blog. I have been agonizing over what to do.

Here is the situation…..I am 50 years old, take home $68,000 a year (total of 2 jobs).

I did the Rave Ramsey Financial Peace University in January 2008. Paid off ALL debt ($8,000) but the house. I have $84,000 left on the mortgage which I plan to have paid off in about 3 years time. Yippii!!!!!! I will then be able to start building some real wealth…at least that is the plan.

I work 2 jobs to make up for my idiotic choices of the past. At my part time job I have a 4% match, which I do. At my full time job they give me 6% of my salary. I do not have to match it. I do contribute 15% at this time. Should I not be contributing and put my money (the 15%) in a Roth IRA. I have not yet started any kind of IRA. I have approx. $100,000 in my combined 403 and 401.

I plan on working both jobs till I am 67…….if only I knew what I know now at 18 :)

Thank you,


She followed up with another email to say that she did have an emergency fund.

Since she didn’t ask any questions I’m going to assume that she wants our thoughts on her plan. A couple of things I noticed:

“I have $84,000 left on the mortgage which I plan to have paid off in about 3 years time. Yippii!!!!!! I will then be able to start building some real wealth…at least that is the plan.”

Although I see nothing wrong with paying off a mortgage early, one thing to keep in mind is that the decision implies an allocation choice. The additional money that you direct towards paying off your mortgage early is money that could be invested elsewhere (like saving for retirement). So, you have to ask yourself if paying off your mortgage early is really the best way to use your resources. I have written quite a bit on this topic in the past. You can find those posts listed under Mortgage in the directory.

“I work 2 jobs to make up for my idiotic choices of the past. At my part time job I have a 4% match, which I do. At my full time job they give me 6% of my salary. I do not have to match it. I do contribute 15% at this time. Should I not be contributing and put my money (the 15%) in a Roth IRA. I have not yet started any kind of IRA. I have approx. $100,000 in my combined 403 and 401.”

I think it’s awesome that you are working two jobs! No, it’s probably not fun but nothing says you have to do it forever.

I think a Roth IRA is a good choice because it gives you some “tax diversification.” You won’t get the tax deduction now, which means your current taxes will be higher. However, income from the Roth will not be taxable (assuming the money has been in there at least 5 years and you are over 59 1/2 when you begin taking withdrawals) AND it Roth income doesn’t count against you in deciding the taxability of Social Security. This is a nice benefit of the Roth that doesn’t get discussed too often. Also, remember that there are no required minimum distributions with a Roth IRA so you could let the money sit there and grow as long as you didn’t need it.

One advantage to working longer is that you can put off taking social security, which means you can expect a larger check when you do begin taking it.

If you would like me and AFM readers to comment on your retirement plan contributions, send me an email and I’ll be happy to take a look at it. There’s just not enough information to be able to tell you how much you could possibly have at retirement. I will say that you seem to be on the right track.