Over the past month, I’ve covered the basics of Roth IRAs. I’ve explained what they are, how (and where) to open one, and which investments are best. Today in the final part of this series, I’m going to answer your questions. Remember: I am not a financial adviser. I’m just a regular guy trying to gather information to help you. If you need more specific answers, please consult a CPA or an investment professional.
All of the questions below were submitted by Get Rich Slowly readers via comment or e-mail. If your question isn’t here, please drop me a line so that I can research an answer and add it to the list. This article isn’t the place to begin if you’re new to Roth IRAs — start here, instead.
- Can I have more than one Roth IRA? For example, can I have one at ING and another at Vanguard?
- You can only have one Roth IRA; however, you can multiple Roth IRA accounts. (As Dylan phrased it: “It’s like J.D. can have multiple blogs, but there’s only one J.D.”) You can have as many Roth IRA accounts as you’d like.
It’s a little inefficient to have multiple accounts spread around, but I can see reasons to do it. I will probably open a second account with Vanguard by the end of the year. (My first account is at Sharebuilder.)
Note that your contribution limit ($4,000 in 2007) applies to all of your IRA accounts collectively; they don’t each get a $4,000 limit. In other words, you can contribute $100 each to 40 different Roth IRA accounts, but not $1000 to each of them.
- Which is better: investing in a Roth IRA (with after-tax dollars) or investing in a 401k (with pre-tax dollars)? Does it make a difference if there’s an employer match? And if I already have a 401k through work, then why would I want to add to a Roth IRA?
The traditional answer to this question is to invest in the following order:
- If your job offers a 401k, contribute to that each year until you’ve reached the limit of the employer match. Never turn down free money!
- If you still have money to invest, contribute to your Roth IRA.
- If you still have money to invest, then max out your 401k.
- Once you’ve contributed all you can to these investments, then invest however you see fit in regular, taxable accounts.
The answer for your situation may be different. Some people like to have all their accounts in one place. If you’re this sort of person, you may benefit from simply putting all your money into a 401k and not worrying about a Roth IRA.
My CPA says, “When debating a 401k vs. a Roth IRA, why not check with your employer to see if they offer a Roth 401k, which combines the best of both worlds?” Also note that you can actually invest in both a 401k and a Roth IRA as long as you meet the requirements for both programs.
- What happens if I contribute too much to a Roth IRA?
- If you contribute more than allowed, you are subject to a 6% excess contribution penalty. However, you have until the annual contribution deadline (generally April 15th) to withdraw any overage from the account before the penalty is assessed.
- How does the IRS know that you contributed to a Roth IRA? How does it know if you contributed more than you were allowed?
- For the answer to this question, I checked with my CPA. “At the end of the year, the investment company submits Form 5498 to the IRS. It reports the amount that you invested. For example, it might say, ‘In 2007, J.D. invested $4,000 in a Roth IRA.’ The IRS computers then match this form electronically to your tax return to check for discrepancies. If you’re over the income limit, your return will be flagged.”
- Can legal U.S. residents who are not citizens open an IRA? Is it a good idea? What if I don’t plan to be in the U.S. at retirement age?
- Anyone with earned income in the U.S. can contribute to a Roth IRA — citizenship is not required. However, for greater flexibility, you may want to consider a traditional IRA or other investment accounts, depending on your goals.
- I have a bank account in the U.S. Can I start a Roth IRA if I live and work in another country? I’m afraid to save in my country’s currency because inflation will ruin my investments.
- No — you must have earned income in the United States in order to open a Roth IRA. However, you can open a regular taxable investment account using U.S. dollars. You won’t get the tax breaks, but if you’re primarily looking to escape inflation in your own country, this might be a good choice.
- Can I really withdraw money from my Roth IRA without penalty.
- Yes, up to a point. You may always withdraw your contributions without penalty or taxes. For example, if you contributed $4,000 last year and the IRA is now worth $5,000, you can take $4,000 out of the account (leaving just the $1,000 in earnings) without consequence. There are taxes and penalties, however, for early withdrawal of earnings for non-approved uses. However, it’s important to note that once you withdraw the contributions you have just 60 days to replace them and after that the money can never be replaced again.
- I’m self-employed and I make more than the maximum allowable for a Roth IRA. Does a SEP-IRA make sense?
- This is another question I bounced off my CPA. He says that a SEP-IRA may make sense, but that it will depend on your individual circumstances. Basically, self-employed people can contribute roughly 20% of their first $200,000 of pre-tax earnings to a SEP-IRA. However, they must contribute the same percentage for all employees. If you are the only employee, or if you don’t mind giving all employees the same retirement benefits, then this may be a good choice. This is another case in which you should consult a financial adviser.
- What options are there if I earn too much to contribute to a Roth IRA?
- If you make too much to contribute to a Roth IRA, be sure you’re maxing out your 401k, if you have one. You can also contribute to a traditional IRA. Both of these are excellent options. (But note that if you have a 401k at work, your contributions to a traditional IRA may not be tax deductible.) For more discussion on this topic, check out this thread from the GRS forums.
- I heard that in 2010 the income limits on Roth IRAs will expire, and that it’ll be easier to roll a traditional IRA into a Roth at this time. Do you have any info on that?
- As the law is currently written, in 2010 the income cap will be lifted on conversions from traditional IRAs to Roth IRAs. But 2010 is a long time from now. There will be a new political environment in 2009. Congress can change current laws, and there’s a good chance they will. Still, if you’re willing to play the odds, putting your money into a traditional IRA now for a potential rollover in 2010 might be a profitable venture.
- My wife is a stay-at-home mom and doesn’t have any earned income. Does this mean she cannot have a Roth IRA?
- To every rule, there is an exception. If you’re married and filing a joint return, then both spouses can max out IRAs from a single income (so long as the other Roth IRA requirements are met). Read more about this subject in the GRS discussion forum.
- Is it possible to roll a 401k into a Roth IRA?
- It is possible, but you have to be careful. It’s not a one-step process. Also, it’s difficult to do with an active 401k account. A mistake along the way could cost you a lot of money, so it’s a good idea to consult a financial adviser for help. There’s a lengthy discussion of this subject in the forums.
- I opened a Roth IRA at a local bank, but I noticed that I’m only getting a 1.98% return. This seems unusually low. Should I withdraw my money and move it to Vanguard, Fidelity, or T. Rowe Price?
- Your money is probably in a savings account or certificate of deposit. Your bank may offer additional financial services — check with them to see where else you can put the money. Barring that, yes absolutely move the money to a different location. You may have to pay a transfer fee, but it’s worth it.
As Mandy writes in the forums, “Traditionally banks are one of the worst places to invest because they typically offer high-load/high-fee or very conservative investments and charge higher service fees than most other brokerages. Banks are for banking, not investing.” (See Which investments are best for a Roth IRA? for ideas on where to put the money.)
- I want to open a Roth IRA, but am confused by the mutual funds offered by different companies. For example, ING Direct offers six funds, and another bank offers only five. What’s the difference? Which should I choose?
- Only you can answer that question. Here’s how I would approach this problem: I would first locate the investment I want to purchase. Is it an individual stock? Is it real estate? Or is it, as I encourage, an index fund? Once you’ve decided on an investment, then find a company that will let you buy the investment from within a Roth IRA. This shouldn’t take too much effort. Zecco, for example, will allow you to purchase any publicly-traded security at basically no charge. If, like me, you decide you like Vanguard’s mutual funds, then open an account directly with Vanguard.
- Can I really use my Roth IRA to buy a house?
- Sort of. You can’t purchase your home with money that’s inside a Roth IRA, but, with certain restrictions, you can take money out of the IRA to do so. As I mentioned earlier, you may always withdraw the full amount of your contributions. You may also withdraw up to $10,000 of earnings in order to purchase a first home.
In many cases, complex Roth IRA questions are best answered by a qualified financial professional. Each person’s situation is different. It’s difficult to give one-size-fits all advice in the context of this blog. Use the National Association of Personal Financial Advisors to find an independent fee-only adviser, or check with the Garrett Planning Network.
Meanwhile, if you’d like more information, check out the following:
- While preparing this entry, I found an excellent Roth IRA guide. It’s thorough but clear.
- Take a look at IRS Publication 590 – Individual Retirement Arrangements.
- Factors to consider when choosing between a Roth IRA and a Regular IRA
- USA Today: Answers to questions about converting from a traditional IRA to a Roth IRA
I’ll pass along additional Roth IRA information in the future. If you have further questions, leave them in the comments here, and I’ll do my best to research the answers for you.
The GRS Introduction to Roth IRAs series
Part 0: How compound returns favor the young
Part 1: What is a Roth IRA and why should you care?
Part 2: How to start a Roth IRA (and where to do it)
Part 3: Which investments are best for a Roth IRA?
Part 4: Questions and answers about Roth IRAs