Where You Can Open a Roth IRA and Other Reader Questions, Answered

Roth IRAs are a powerful retirement investment vehicle accessible to almost all Americans, but the specifics of how to start and use one can be a little tricky. Knowing the difference between a Roth IRA and a 401(k) is a great starting point, here are three questions from readers on some of the details of Roth IRAs.

1. Where can I open a Roth IRA?

How do you even start a Roth IRA? Articles always say to use a “brokerage” or “investment firm” or “bank.” Which one?

– Mira

A Roth IRA can potentially be at any of those places. Many large financial institutions, including almost every large bank and virtually every brokerage or investment firm, offers the capacity to manage a Roth IRA for you. A Roth IRA is simply a type of account you have there that has some special tax benefits for retirement, and within that account, you can decide how the money is utilized. You deposit money and withdraw it, just like any other account.

[ Next: IRA Contribution Limits and Rules ]

So, where exactly should you host your Roth IRA? There are plenty of Roth IRA accounts available. Right now the best option for beginners is currently Charles Schwab and the best average returns currently Vanguard, which I happen to personally use.

The first question you should really ask yourself is what you need from that account. Do you feel confident making investment decisions on your own within that account? If so, you’re probably better off choosing an account that either has the best returns or offers the most research tools, but you’re not really worried about help every step of the way. On the other hand, if you don’t feel confident, a Roth IRA with a firm that specializes in rich investment advice and help for beginners is probably a good choice, as the investment returns are going to be fairly comparable either way.

2. How to convert an old 401(k) into Roth IRA

I have an old 401(k) from a job I worked at from 2005 to 2009. I literally haven’t touched it since, but the value has gone up nicely. I would like to convert it into a Roth IRA for tax benefits and to have more control. I read that this could be done but the article was really confusing and I hope you can make it more clear.

– Steffen

This is known as a rollover, and it can be done, but there’s going to be a pretty notable tax bill for you in the process.

The money in your 401(k) is money on which you never paid income taxes. Rolling that money to a Roth IRA means that you have to treat that 401(k) money as income during the year in which you do that rollover.

So, if you have $50,000 in your old 401(k) and you want to roll it over to a Roth, that’s great, but it’s going to bump up your taxable income for the year by $50,000, and that means you’re going to have to pay taxes on that money. If you have a lot of other income, your tax bill will be pretty high; if you don’t have a lot of additional income, you’ll still find yourself with a modest tax bill.

In terms of the mechanics of it, any investment firm that is hosting your Roth IRA will be able to easily walk you through the steps of doing this.

Is that rollover worth it? It depends on your financial situation. If you have the ability to cover the tax bill, converting an old 401(k) to a Roth IRA is a good thing to consider during any year when your other sources of income are low, such as a year where your business isn’t doing well or you were unemployed for a while. Doing it at this time means that you’ll end up in a lower tax bracket than you would have in a normal year and thus won’t owe as much in taxes for the rollover.

There are other options you can take if the tax bill seems overwhelming. You can split the rollover between a traditional IRA (where you don’t have to pay taxes now, but later when you’re withdrawing in retirement) and a Roth IRA, balancing the two so that you can handle the tax bill. 

If you’re strongly considering this, it’s probably worth your while to hire a fee-only financial advisor or accountant to help you run the numbers so that you know the exact tax consequences of each option.

3. Making 2020 Roth IRA contributions in 2021

I read that you can make contributions to your Roth IRA in 2021 and have them count for 2020. How does that work?

– Kevin

The deadline for contributing to a Roth IRA for 2020 is April 15, 2021, the federal income tax filing day. You actually don’t have to do anything special at all. However, when you make a contribution to that account, the brokerage will ask you, during the period between January 1 and April 15, whether it is a 2020 or a 2021 contribution.

In terms of filing your taxes, there’s no difference in terms of your tax bill — after all, Roth IRAs are contributed to with after-tax money. In May, your investment firm will produce IRS form 5498 and send it to the IRS automatically on your behalf, which will summarize all of your contributions assigned to 2020, even if you made them early in 2021. As long as you designate them for 2020 and make the contributions before April 15, they’ll count for 2020. You don’t have to lift a finger for this form — your investment firm generates it and sends it automatically to the IRS.

[ More: When You Should and Shouldn’t Pay Someone to Do Your Financial Tasks ]

Why does that happen? The IRS wants to ensure that you’re following the IRA rules, chiefly these three things:

1. You’re not exceeding the contribution limit to your Roth IRA. For the 2020 tax year, that cap is $6,000 per person, or $7,000 if you’re age 50 or older.
2. You’re not exceeding the income limits for a Roth IRA – $139,000 for a single filer in 2020 and $206,000 for a married couple filing jointly.
3. You’re abiding by the “five-year rule,” which imposes some limitations on Roth IRA withdrawal if the account is less than five years old. For this, it’s just verifying that you’ve made contributions during this year, so that your five year clock begins (if it hasn’t already). Five years from now, the rule doesn’t matter anymore.

As long as you’re under those caps, you’re fine!

Do you have any questions? The best way to ask is to follow me on Facebook and ask questions directly there. I’ll attempt to answer them in a future mailbag (which, via full disclosure, may also get re-posted on other websites that pick up my blog). However, I do receive many, many questions per week, so I may not necessarily be able to answer yours.

We welcome your feedback on this article. Contact us at inquiries@thesimpledollar.com with comments or questions.