Retirement Accounts

This information is gathered from various sources and is a bit random and shallow at present.

Retirement Accounts are a method for people to save for the future - specifically, retirement. The primary difference between a retirement account and any other kind of investment account are the tax benefits given to retirement accounts - and the restrictions and penalties put in place in exchange for the tax break.

Worth noting: there are different kinds of retirement accounts. The acronym "IRA" (Individual Retirement Account) is used in this document as a generic term for all the various kinds of retirement account (including 401K, 403B, Managed Pensions, etc.) - the specific differences are explored a bit later.


Traditional IRA

Contributions to a traditional IRA are made with pre-tax dollars (or are deducted from taxes in the present), but taxes must be paid in retirement, when the funds are withdrawn.

Contributions can be made at any age, up to 70.5. The current limit is $5000 per person under 50, $6,000 per person age 50 and older. This goes for the deduction you can take for an out-of-pocket contribution. I have the sense that funds withheld from a paycheck may be subject to different limits.

Withdrawals can be made after age 59.5 without penalty, but the withdrawals are treated as taxable income in the year they are withdrawn.

If you withdraw before that age, you will pay a 10% penalty on top of taxes, except for a few reasons:

In any of these cases, the penalty is waived, but you must still pay the taxes.

Roth IRA

A Roth IRA is funded with after-tax income presently (no tax deduction), but withdrawals made during retirement are tax-free. However, to be eligible at all, your income must be less than $110,000 (single) or $160,000 (joint)

Withdrawing funds before age 59.5 incurs a 10% penalty (but no tax consequences). Additionally, you must have held the account for at least five years before taking distributions to avoid this penalty (you cannot start a Roth IRA at age 58 and start withdrawing tax-free earnings two years later - in this case, you must wait until age 63)


The Simple IRA and SEP (Simplified Employee Pension) plans were established to help small employers and self-employed individuals to take advantage of retirement programs. There isn't much detail provided, and these are fairly rare, so I'm not going to do much research into these programs.

Employer Plans

An IRA is generally an account that is created and funded by an individual independent of their employer. Many companies offer retirement accounts (401K, 403b, etc.) that are similar to an IRA in many respects, and funds from such a plan can be rolled into a private IRA (and back, provided the funds are not commingled with out-of-pocket contributions).

These employer-provided plans are largely similar to IRAs that a person sets up privately. The functional differences, from an account holder's perspective, are that:

Otherwise, the accounts are similar to identical in their terms.

Brokerage IRA

The term "brokerage IRA" seems to indicate a retirement account of any type which the individual manages as a brokerage account, buying stocks, bonds, and other securities.

Brokerage firms seem to favor this arrangement because they earn more commissions on trades when an individual actively manages his account, and speculators seem to favor them for the sake of having more personal control over the management of their funds.

My take is that it enables (and even encourages) individuals to engage in risky investments with their retirement funds, so I've avoided getting involved or delving much deeper.

Choosign a Plan

Various advice is given on choosing the "right" IRA, but much of it comes down to a person's individual financial situation: their current tax rate, the tax rate they expect in retirement, the time duration and amount contributed, and which plans are available. There doesn't seem to be any general guidance.


There are a lot of subtleties and specifics to individual plans, but to distill it down to the basic common factors:


Traditional-to-Roth Conversion

It is suggested that converting to a Roth is a good idea if the taxes can be paid from a separate source (not deducted from the principal). However, most sources ignore the fact that the money used to pay taxes and penalties could have been invested elsewhere, and the potential value of those funds are conveniently excluded from the comparison. I suspect brokers want to encourage the conversion because they turn a nice profit on the commissions from selling out of the old and buying into the new, and may be sweeping a few unflattering details under the rug.

Doing the math for myself (roth-covnersion.xls), it's a pretty close call. There is a negligible difference (less than $1,000 per month) in favor of the Roth conversion, provided that the individual remains at the same tax rate in retirement. If the tax rate is 2% less in retirement (which is likely, as income needs are more modest and the individual can manage their tax liability better), the equation favors remaining in a traditional IRA.


An IRA can be transferred from one firm to another at will, the exception being employer plans, which generally prohibit moving the account so long as the individual remains employed. Upon termination or separation, an employee may have the funds paid out (bad idea: penalties and fees apply), they may leave the funds' in the plan (provided the balance is sufficient by the plan's terms), or they may "roll over" the IRA into another employer's plan or a privately-held IRA. The choice to leave the funds in the employer's plan does not preclude the option to roll them over at a future date.

The rollover needs to be handled with care. Ideally, the funds will be moved out of the existing plan and into the new one without passing through the owner's hands, such that the transition is seamless. If the rollover is "indirect," the individual may be required to pay taxes out of pocket (or they may be withheld by the old plan), and then recover them when taxes are filed. It's a bit messy, and best avoided.

One rollover option is to move funds from a previous employer's plan into a current employer's plan, rather than into a private IRA, in order to consolidate accounts, which generally can be orchestrated so that there are no taxes or penalties. A private IRA may also be rolled into an employer's plan, but only if that IRA contains rollover funds from previous employer plans (if any direct contributions have been made, it cannot be rolled over).

A few notes from personal experience: The companies that manage retirement funds do not like to "lose" your business and will make it as difficult as possible to move your funds to another firm. They will try to talk you out of it, put in place difficult procedures and lengthy forms, come up with new "requirements" to string you along, and even result to unethical practices (such as telling you that you're not allowed to move the funds, misinform you about the necessity of taxes and penalties, or "lose" required paperwork you've sent them) to maintain control of your account. IT could be that I've just had bad luck or dealt with a few rotten firms, but I've done this a few times, and have never had a good experience. It's always taken months or years of badgering and jumping through hoops to get funds moved.

Contributing to a Spouse's IRA

Contributing to a spouse's IRA is allowable for a person to contribute to their spouse's IRA (A private IRA, but generally not an employer plan), subject to the standard limitations.

This is generally done for traditional IRAs when there is one partner over age 70.5 (and cannot contribute to their own IRA) and another who is under the age limit, who is not working (or not making enough money to fully fund their own IRA).

Required Distributions

With a traditional IRA, you are required to take a certain amount of funds as a distribution, starting at age 70.5. There is a table that provides a "life expectancy factor", and you must withdraw at least that much from the IRA.

For example, at age 75, life expectancy factor is 22.9 - so if you have $500,000 in an IRA, you must withdraw at least $21,834.06 that year ($500,000/22.9) ... or pay a heavy penalty (50% of what you neglected to withdraw).

Inheriting an IRA

When someone dies and leaves and IRA to someone, the beneficiary has a few choices as to how to handle the funds:

  1. Inherit the IRA and treat it as if it were their own IRA
  2. Take the minimum distributions (and pay taxes), the same as the owner would have if he were still alive, provided the heir is of retirement age (59.5) or is the spouse of the deceased
  3. Withdraw the full amount (and pay and penalties if applcable).

If the heir fails to choose an option by December 31 of the year following the owner's death, the first option will be assumed.

If an IRA is left to a beneficiary other than an individual (an organization), the funds must be withdrawin and applicable taxes paid within five years.

The options are a little different for SIMPLE and SEP accounts, but again, they are rare, so I'm skipping them.