An Individual Retirement Account is a particular type of retirement plan bank account that was first created in 1974, when the Employee Retirement Income Security Act (known as ERISA) was passed.
ERISA was a huge bill of tax and labor law that encompassed regulations for everything from pension and retirement plans to health care plans and the taxes associated with all of those things. The act established minimum standards for pension plans, rules for the administration of such plans, and appropriate standards of conduct for people who are in charge of administering such plans. The act is very clear on the fiduciary duty held by such administrators, so that the best interests of the employees, or the beneficiaries of the plan, are always the goal.
The ERISA laws were enacted after several large companies – most notably the Studebaker car manufacturing company – went out of business and could not (or at any rate, did not) live up to the agreements they had made with their employees in regards to pensions. Studebaker eventually gave only those employees who were over age 60 their full pensions, with all other employees getting either a tiny portion of what they had earned or nothing at all. Understandably, this and other failures of companies to live up to their obligations to provide pensions to their employees, caused an uproar in the labor community. Unions were adamant that something had to be done, and since in the early 1970’s there were nearly 20 million Americans who were union members, they had a strong voice and were a force to be reckoned with. They lobbied for laws to be enacted that would enable workers to be confident that their retirement plans would be there when they retired, and could not disappear at the whim of an employer. Their demands resulted in the creation of the ERISA act, and ever since, people have been putting money away and managing their IRA accounts in the sure knowledge that by doing so, they will have at least something put by when they retire. The original plan has been changed quite a bit since 1974, with the Reagan administration watering it down in the 1980s and other changes being made since then. Today’s IRAs are subject to different rules than those of the 1970s, but they are still widely used, with around a quarter of Americans participating in the plan. IRAs are typically used by workers who do not have an employee plan through their workplace, or who are not confident that a workplace plan will be enough to live on when they retire.
An Individual Retirement Account, or IRA, is just one of a group of retirement plans that all fall under the heading of Individual Retirement Arrangements, or IRAs. If this seems confusing, it’s probably because it is. The accounts that fall under this general heading of Individual Retirement Arrangements are things like the Roth IRA, the Traditional IRA, myRA, SEP IRA, Rollover IRA, Simple IRA, and Conduit IRA. Each of these accounts have a common basis, but cater to different needs for the worker. Many banks or financial institutions will advertise “Self-Directed” IRAs, but the term is redundant because the basis of an IRA is that it is self-directed. They all are.
The original Traditional IRA allowed workers to contribute a set amount each year to their IRA, and that money was not taxed until it was withdrawn from the account. There are many different rules pertaining to the money that is invested, and different taxation laws that must be taken into consideration when an investor is deciding what to do with their IRA funds, and it is necessary to learn as much as possible about IRAs and how they work so that, as an investor, you can make good decisions regarding your funds. The IRS website is a good source of information about IRAs and with some careful reading, you can learn all you need to know to manage your money in the best way possible. There are many other websites that will give you good information, but the IRS site will give you the current tax rules, whereas another website may not.
One of the most common types of IRA is the Rollover IRA. These are IRAs that allow you to take your retirement plan from your job (usually a 401K) and roll it over into an individual retirement account without having to pay the taxes on that money (if you just took the money out of the 401K and put it into a regular savings account you would have to pay the taxes on that money, which often add up to a significant amount, as well as penalties for removing the money before the agreed time) in effect, protecting the money and the tax savings by moving the money without causing it to be classed as taxable income. Some people say that Rollover IRAs have essentially become obsolete under current tax law, but there are still many IRA plans that only accept funds from Rollover IRAs or Conduit IRAs, so it is important to understand the rules before moving your money.
When you are employed, your employer manages your retirement plan, which is usually called a 401K, but when you leave that employer, you will need to make decisions regarding what to do with the money that is in your 401K. If you just withdrew the money, you would immediately be required to pay both federal and state taxes on it, as well as penalties for withdrawing it early. If you want to avoid these penalties, there are ways to transfer the money without incurring those charges. If you follow the rules, you can roll the money over into an IRA without it costing you a lot of money. You will need to make sure that you deposit the money into your IRA within 60 days of removing it from the 401K. If you use a direct rollover method when you withdraw the money from your 401K, the check can actually be made out to the institution where it will be deposited in the IRA. This allows you to skip the step that says you must take 20% of that money for federal taxes and send it to the IRS immediately, and it means that you will not be charged taxes or penalties on that 20% when you put the remainder into an IRA.
Timing is important with your IRA, as well. You will need to keep yourself up to date on the rules that apply to how often you can roll your money over, how often you can distribute assets from your retirement funds, and what each of those moves might cost you in terms of fees, penalties, and taxes. It is really important to be sure that you are abiding by the current rules, since the laws do change on a fairly regular basis.
Using the 60-day rule, you can, in effect, borrow from your IRA for a short time, but you must have the full amount of money to deposit in your IRA before the deadline, or you will be subject to the taxes and penalties, and that could cost you a huge chunk of your retirement savings.
You need to take into account that your retirement savings – either in a 401K or an IRA – may or may not be protected if you were to be sued, depending on the state you live in. People who have a lot of assets in their retirement plans may want to consider an umbrella insurance policy that can help provide coverage in the event of a lawsuit, to prevent their retirement plans from being depleted. Learn the rules in your state, and protect yourself accordingly.
Sometimes, using a rollover is not the best possible option for moving your money. If you want to change banks, you can just transfer your IRA from one bank to another. The money moves without you having to be physically involved in the transaction at all, and you do not have the 60-day rule to contend with. There is no check involved that could potentially be lost or accidentally destroyed, and the money is not subject to any penalties or taxes. In some circumstances, a direct transfer is a much wiser option than a rollover.
In some cases, you may want to roll your money from an IRA into a 401K – sometimes this is a good idea if you have started a new job and want to keep all of your retirement funds in one spot. Not all plans will accommodate this, though, so you will need to check with the plan administrator to see if it is possible, and do your research to find out if it is financially viable or if there will be penalties or fees that will need to be paid. some types of savings plans are not eligible to be rolled over into an IRA, such as RMDs and nontaxable savings.
The best thing you can do when managing your IRA is to put in the effort to know the rules, and make sure you know where your money is and what it is doing at all times. Never be afraid to ask questions of a financial advisor, but be careful about simply taking their word for everything. If you are in doubt, check out the IRS website and read the rules for yourself.