Rollover or Traditional IRA

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Topic Author
62nc
Posts: 32
Joined: Mon Jun 27, 2016 3:34 pm

Rollover or Traditional IRA

Post by 62nc » Fri May 22, 2020 3:44 pm

My wife has some 401k funds that we want to consolidate all under vanguard for simplification. She currently has a Roth IRA at Vanguard and two 529 accounts. She does not currently have a Traditional IRA.

We started the process on the Vanguard site, and we got to the end and the account type is Rollover IRA and not Traditional IRA. I am wondering do we:
a) just go with the Rollover IRA which the Vanguard site popped out with or
b) create a traditional IRA and roll it into that

What are the pros and cons of each? I understand that the rollover features are such that they could be rolled back into future employers' plans, but why would we want to do that versus just keeping in Traditional and self-manage at Vanguard?

The total amount is relatively small as well, so I had thought over the long term we could gradually convert some of these traditional funds to her Roth, paying taxes along the way, but eventually leaving her primarily with a Roth focused Vanguard approach. And then hopefully in the long run if our incomes go over limits, we could use the traditional to fund backdoor roth. On the surface - traditional seems more flexible.

Which should I choose? Rollover or Traditional?

tashnewbie
Posts: 175
Joined: Thu Apr 23, 2020 12:44 pm

Re: Rollover or Traditional IRA

Post by tashnewbie » Fri May 22, 2020 3:54 pm

Rollover and Traditional IRAs are basically the same thing. A Rollover IRA is generally one that has been transferred from a pre-tax employer's plan like a 401k. You can also open up a standalone Traditional IRA. They are both pre-tax accounts, assuming deductions have been taken for the t-IRA contributions.

In your case, it's just semantics. I would designate it as a Rollover IRA. If it's a really small amount that won't push you into a higher tax bracket, it might be worth going ahead and converting it into the Roth (will be a taxable event). Otherwise, if your income increases and exceeds Roth contribution limits, having the Rollover IRA will make a backdoor Roth more complicated (will run into pro rata taxes, unless you transfer Rollover IRA into an employer's plan or convert entire account into Roth).

lakpr
Posts: 4971
Joined: Fri Mar 18, 2011 9:59 am

Re: Rollover or Traditional IRA

Post by lakpr » Fri May 22, 2020 4:01 pm

Please read the last two sentences in @tashnewbie's response VERY CAREFULLY!!. If your combined income is anywhere near $196k (and will be expected to be so in future years, inflation-adjusted), then you are better off NOT rolling over this 401k into Rollover IRA.

Roll the money into the 401k plan instead.

rkhusky
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Joined: Thu Aug 18, 2011 8:09 pm

Re: Rollover or Traditional IRA

Post by rkhusky » Fri May 22, 2020 4:03 pm

They are essentially the same thing. Just go with Vanguard’s suggestion.

tashnewbie
Posts: 175
Joined: Thu Apr 23, 2020 12:44 pm

Re: Rollover or Traditional IRA

Post by tashnewbie » Fri May 22, 2020 4:03 pm

lakpr wrote:
Fri May 22, 2020 4:01 pm
Please read the last two sentences in @tashnewbie's response VERY CAREFULLY!!. If your combined income is anywhere near $196k (and will be expected to be so in future years, inflation-adjusted), then you are better off NOT rolling over this 401k into Rollover IRA.

Roll the money into the 401k plan instead.
I agree completely - if there is a new 401k plan available and the options are at least decent, it's probably better to just transfer to the new 401k.

Topic Author
62nc
Posts: 32
Joined: Mon Jun 27, 2016 3:34 pm

Re: Rollover or Traditional IRA

Post by 62nc » Fri May 22, 2020 4:18 pm

There’s not a new employer. She is currently not working.

Seems like traditional IRA is best if we are approaching the Roth limits in the future?

tashnewbie
Posts: 175
Joined: Thu Apr 23, 2020 12:44 pm

Re: Rollover or Traditional IRA

Post by tashnewbie » Fri May 22, 2020 4:20 pm

62nc wrote:
Fri May 22, 2020 4:18 pm
There’s not a new employer. She is currently not working.

Seems like traditional IRA is best if we are approaching the Roth limits in the future?
It won't matter if it's classified as a Rollover or Traditional IRA for purposes of Roth contributions when you're over the income limit, because both will be treated the same. I'd just identify it as a Rollover.

lakpr
Posts: 4971
Joined: Fri Mar 18, 2011 9:59 am

Re: Rollover or Traditional IRA

Post by lakpr » Fri May 22, 2020 4:33 pm

tashnewbie wrote:
Fri May 22, 2020 4:20 pm
62nc wrote:
Fri May 22, 2020 4:18 pm
There’s not a new employer. She is currently not working.

Seems like traditional IRA is best if we are approaching the Roth limits in the future?
It won't matter if it's classified as a Rollover or Traditional IRA for purposes of Roth contributions when you're over the income limit, because both will be treated the same. I'd just identify it as a Rollover.
Having the money classified as a Rollover may allow for the money to be moved into a 401k plan if she has any plans to seek employment in the future.

Topic Author
62nc
Posts: 32
Joined: Mon Jun 27, 2016 3:34 pm

Re: Rollover or Traditional IRA

Post by 62nc » Fri May 22, 2020 5:05 pm

tashnewbie wrote:
Fri May 22, 2020 4:20 pm
62nc wrote:
Fri May 22, 2020 4:18 pm
There’s not a new employer. She is currently not working.

Seems like traditional IRA is best if we are approaching the Roth limits in the future?
It won't matter if it's classified as a Rollover or Traditional IRA for purposes of Roth contributions when you're over the income limit, because both will be treated the same. I'd just identify it as a Rollover.
But I thought to do a backdoor would require pushing money into traditional IRA, then converting to roth?

But if I have a rollover IRA account, I was reading I can't co-mingle new contributions though?

lakpr
Posts: 4971
Joined: Fri Mar 18, 2011 9:59 am

Re: Rollover or Traditional IRA

Post by lakpr » Fri May 22, 2020 5:47 pm

62nc wrote:
Fri May 22, 2020 5:05 pm
tashnewbie wrote:
Fri May 22, 2020 4:20 pm
62nc wrote:
Fri May 22, 2020 4:18 pm
There’s not a new employer. She is currently not working.

Seems like traditional IRA is best if we are approaching the Roth limits in the future?
It won't matter if it's classified as a Rollover or Traditional IRA for purposes of Roth contributions when you're over the income limit, because both will be treated the same. I'd just identify it as a Rollover.
But I thought to do a backdoor would require pushing money into traditional IRA, then converting to roth?

But if I have a rollover IRA account, I was reading I can't co-mingle new contributions though?
You are conflating multiple issues.
1. Money can be contributed to a Traditional IRA either as a deductible contribution, or a non-deductible contribution. It's also possible that one year you may have made a deductible contribution, whereas the next year you did not.

2. When you convert money from a Traditional IRA to Roth, it is ALWAYS treated as a proportional conversion of pre-tax amount and non-deductible amount. You are expected to pay tax only on pre-tax amount
2a. For the purposes of this calculation, the IRS treats ALL Traditional IRAs including Rollover IRAs, held at any custodian, as one giant Traditional IRA.

3. I think in 2010 or so, the income limit on Roth conversions is removed. I believe, prior to that, you cannot even convert money from Traditional IRA to Roth IRA if your regular income exceeded a certain threshold

4. While it is less common now, in the past, 401k plans refused to let money from other than 401k plans and Rollover IRAs. In addition, if a Rollover IRA has contributions made to it directly after its creation through rollover of an old 401k plan, money from that Rollover IRA was also not allowed in. But note that the 401k plan looking to accept money from the Rollover IRA, will be looking at only this particular Rollover IRA. It's not concerned with other Traditional IRAs you may have, with are funded through direct contributions, deductible or non-deductible. They just want to see that no further contributions after the IRA is initially established, except rollover from another 401k plan if you happen to change jobs again.

Now, in (2), if you do NOT have any non-deductible contributions to the Traditional IRA, then 100% of the amount you have converted is taxable income. This appears to be your situation, so along with (3), you are good to do this at any time. This is clean.

Backdoor Roth is, indeed, require pushing money to a Traditional IRA and then converting to Roth. But the contribution is made on non-deductible basis first, that is, the contribution is never intended to be deducted from taxes. At the conversion step, as I wrote in 2a, if you have any existing pre-tax Traditional IRA or a Rollover IRA at any custodian, you ARE subject to pro-rata rules. Which almost negates the advantage of Backdoor Roth conversion.

Note that in (4), you are only bleeding money out of the Rollover IRA to a Roth IRA. You are not CONTRIBUTING to it any more. That is also clean. At any time in the future you want, you may choose to roll into a 401k plan whatever is left in that Rollover IRA.

Note also that, in (2) you are dealing with the IRS. The focus of the IRS is ALL Traditional IRAs and Rollover IRAs.
In (4) you are dealing with only the 401k custodian and that custodian's focus is only that one Rollover IRA account.

So, if you are harboring any hopes that you may want to roll the Rollover IRA to a a new employer 401k at any time in the future, simply designate the IRA as Rollover IRA and do not contribute at all to that particular account in the future.

If rolling into a future employer 401k is not even on the table, then the exact designation of the account does not matter. Nor does future addition to that Rollover IRA or Traditional IRA account.

Hope what I am saying is clear. Or may be not ...

Topic Author
62nc
Posts: 32
Joined: Mon Jun 27, 2016 3:34 pm

Re: Rollover or Traditional IRA

Post by 62nc » Fri May 22, 2020 6:38 pm

Would the best option be to do the current funds into a Rollover IRA for now.... then at some later date if the need should arise to contribute into a traditional, just open another traditional IRA at that time?

I assume it is allowed to have Roth IRA, Traditional IRA, and Rollover IRA accounts open under the same social? Contributions would first go to Roth, then if we hit income limits, I could use Traditional. And then leave Rollover untouched until the point we're confident we'd never want to roll them into employer.

Is that the best approach?

tashnewbie
Posts: 175
Joined: Thu Apr 23, 2020 12:44 pm

Re: Rollover or Traditional IRA

Post by tashnewbie » Fri May 22, 2020 7:01 pm

62nc wrote:
Fri May 22, 2020 6:38 pm
Would the best option be to do the current funds into a Rollover IRA for now.... then at some later date if the need should arise to contribute into a traditional, just open another traditional IRA at that time?

I assume it is allowed to have Roth IRA, Traditional IRA, and Rollover IRA accounts open under the same social? Contributions would first go to Roth, then if we hit income limits, I could use Traditional. And then leave Rollover untouched until the point we're confident we'd never want to roll them into employer.

Is that the best approach?
If you ever reach the point where your MAGI is too high to contribute directly to a Roth, you probably should just add money to a taxable brokerage account instead of a non-deductible TIRA. There are very few reasons when it makes sense to do the latter; there is a BH wiki about it. If you reach that point and really want to continue adding to a Roth you will encounter the pro rata rule and if you want to avoid it you’d have to convert the Rollover IRA by paying taxes on it (assuming there’s no new 401k that you can transfer it into). A user above gave a thorough description of how this all works.

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