How to Manage Your IRA Contributions

Getting money into your IRA is where the magic begins. You can’t build a portfolio until a source of funds exists. IRAs give you not only big leeway in what investments you buy but also lots of control over how you buy those investments.

Set up IRA deposits

When you’re talking about putting money aside that you can’t touch for decades, it’s easy to understand why lots of people put off retirement savings. Let’s face it, blowing $800 on a new smartphone is more immediately satisfying than putting $800 in an IRA. IRA providers know this, and go out of their way to make it easy for you to get money into your account. You can make ongoing contributions to your IRA in two main ways:

• One-time contribution: The IRA provider lets you connect multiple checking and savings accounts to your retirement account. You can then tell the provider to digitally pull money from one or more of those accounts as a contribution. Vanguard’s one-time contribution screen, shown in Figure 8-5, asks you to choose the investment you want the money to go into. It also tracks your annual contribution to date.
• Automatic contribution: You can also tell your IRA provider to take money from a checking or savings account, say every month or quarter. This method puts your retirement plan on autopilot.

It’s up to you to make sure your contributions meet the requirements and don’t exceed limits. If you’re covered by a retirement plan at work, the IRS spells out whether you can deduct your IRA contributions. If you make too much money, the deducible amount of your contribution is reduced or eliminated. In a nutshell, if you made more than $74,000 as a single taxpayer or $123,000 married filing jointly and are covered by a plan at work, you can’t deduct IRA contributions.

Roll over Beethoven: IRA rollovers

Another way to fund an IRA is a rollover. You might opt to rollover your old 401(k) from a previous place of employment, which can be a good idea if your old 401(k) has high fees or poor investment choices. You can rollover funds also from one IRA to another, although that process is usually called a transfer.

Generally, it's best to keep your retirement accounts in as few places as possible. Consolidating your retirement funds with one IRA provider helps you qualify for lower-priced investments and makes it easier to keep track of your money.

A rollover involves three steps:

1. Fill out your IRA provider's rollover form. The form is usually short, asking for the account number and the provider holding the funds now. You’ll also be asked if you’d like to roll the funds into a new IRA or an existing one.
2. Notify the 401(k) or IRA provider you’re moving from. Tell them you’re moving the money and where you're moving it. The provider will cut a check for the money.

   Make sure the check is made out to the firm where the money is going, not to you. If the money goes to you, the IRS might think you took a distribution and hit you with a tax bill.

3. Wait. A rollover can take a few weeks. Your new IRA provider will let you know when the process has been completed.

Fund an IRA with a Roth conversion

With traditional IRAs, you get a tax break now. With a Roth IRA, you pay now but take out the money later free and clear. Guessing which will be best for you is difficult. In general, a Roth is a good idea if you think your current tax rate is lower than it will be when you’re retired.

Roth IRAs are preferable also if you think you might need to pull the money out sooner than in retirement, or if you think you won’t need the money and want to leave it for a spouse or an heir. Traditional IRAs require you to take money out when you turn 70-1/2. With a Roth, you can leave the money in.

Given all the guesswork in choosing a Roth IRA versus a traditional IRA, you might change your mind about the kind of IRA you want. That’s where a Roth conversion comes in. You can turn a traditional IRA into a Roth IRA if you pay the taxes now.

Converting a traditional IRA to a Roth can make sense. It’s also a back door way to open a Roth for people who earn too much to fund a Roth. A Roth conversion has several drawbacks, however. You must wait at least five years after a conversion to take money out of a Roth. The conversion also triggers a tax event — you’ll have a tax bill on those tax-deferred contributions.

Does a Roth conversion make sense for you? To answer that question, you can use a variety of online tools, including the following:

• Schwab IRA Conversion Calculator: This tool helps you think about all the important variables that determine whether or not you should convert to a Roth. These variables include the amount of money you’d like to convert and your taxable income.
• CalcXML’s Roth Conversion Calculator: This tool does all the math to see whether a Roth conversion makes sense. The calculator considers the size of the conversion as well as your age and income needs.