Ready or not, there may be an IRA in your future
Hardly anyone invests money in Individual Retirement Accounts anymore, yet more people are winding up with these tax-sheltered accounts.
That seeming oxymoron can be explained by noting there are different types of IRAs. Contributory IRAs — those opened with new investment dollars or contributions — aren't feeling much love these days. Yet rollover IRAs — those funded from other accounts, especially workplace 401(k) plans — are thriving.
So even if you never contributed to an IRA and don't plan to, you should still make sure you understand a few basics on how IRAs work — just in case you go the rollover route.
The key feature that unites all IRAs is some type of federal income tax benefit. At a minimum, your investments grow tax-deferred until the money's withdrawn. With a traditional IRA, you also can deduct the amount of your contributions. With a Roth, you don't get a front-end deduction but typically can withdraw money tax-free.
Neither of these two basic types of contributory IRAs is especially popular. Partly that's because the rules are confusing, partly it's because many people have access to 401(k) plans at work (frequently offering employer matching funds) and partly it's because Roth and deductible IRAs aren't available to everyone — eligibility is curtailed for high-income Americans who have access to 401(k) or other workplace retirement plans.
So perhaps it's no great surprise that not even 12 percent of traditional and Roth IRAs received contributions in 2014, the most recent year examined by the Employee Benefit Research Institute.The Washington, D.C.-based group has an ongoing study that collects data on nearly 27 million IRAs owned by 21 million people.
A mere 7 percent of traditional IRA owners made new contributions that year.
Roth owners were a bit more enthusiastic, with 26 percent of them adding new money. They should be enthusiastic because Roths, even without a tax deduction, offer some key tangential benefits of which more people are becoming aware, especially as they near retirement age.
One big one is that you don't have to take money out of a Roth after you reach 70 1/2. By contrast, required minimum distributions on traditional IRAs are taxable as ordinary income and could be high enough to push some of your Social Security benefits into the taxable category. And even if you did make a Roth withdrawal, the money comes out tax-free, meaning it still wouldn't make your Social Security payouts taxable.
So what are rollover IRAs, and where do they stand? In large part, they are tax-sheltered vehicles into which you can move money from 401(k) plans and other retirement programs if you leave your job and don't need to spend all the money yet, though some rollovers come from prior traditional IRAs.
"A substantial and growing portion of these IRA assets originate in other ... retirement plans such as defined benefit (pension) and 401(k) plans," wrote Craig Copeland, a senior research analyst at the institution who authored the study.
In terms of accounts, IRAs funded by new contributions still outnumber those opened with rollovers, by roughly a three-to-two margin, according to the EBRI study. But a lot more money — nearly 15 times more — is pouring into the latter.
This isn't too surprising given that investors are capped in terms of how much money they can contribute to an IRA. The yearly maximum is $5,500, or $6,500 for people 50 and up, who can sock away an extra $1,000 each year. More telling, investors can roll over virtually unlimited sums, and the amounts they do roll over may reflect years of participation in workplace plans or other IRAs.
The median or midpoint rollover amount was more than $25,800, according to the study. On average, investors have slightly more than half their account balances in stocks and stock funds, though the report noted what it called "extreme allocations" that were especially heavy or light in stocks and stock funds. Some 27 percent of all IRAs had an extreme allocation of less than 10 percent in equities, while 28 percent had an extreme allocation of more than 90 percent.
Incidentally, most mainstream financial companies will help you open a rollover IRA, including nearly all of the same entities that handle contributory IRAs.