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Opus 17 · ‎September 20, 2021

@SLYKTAX wrote:

Five questions I need to ask the experts here.

1. 401K is a pretax retirement account similar to a Traditional IRA account . Why people talk about converting his 401K to Traditional IRA Account when both work the same?

2. I retired on12/2020 from a local government with a buyout and $70K is only due for payment by the end of this year (2021). I have already rolled over all my 457 retirement account to a Rollover IRA Account in SCHWAB. If I get my W2 form for the $70K, can I contribute the maximum to my Rollover IRA for 2021 and also contribute $7,000 to ROTH?

3. The 60 days limit time frame for conversion. Does that mean I have 60 days to decide whether to contribute to IRA once I get the payout or not?

4. As I have retired, can I still contribute to ROTH and IRA if I get my W2 form for the $70K?

5. IRA conversion to ROTH. Does the 60 day limit means I can take my IRA distribution in 12/31/2021 and have another 60 days to decide to convert it to my ROTH IRA? Can I return the distribution if my AGI take me to a higher tax bracket?

Thanks

1. Although a traditional IRA and a 401(k) have similar purpose, they are controlled by different sections of the tax code and have some rules that are very different, especially regarding exceptions to the 10% penalty for early withdrawals. Some employers might force you out of their plan when you separate from service, especially if the balance is small. Some employers might have restricted investment options, since they have a fiduciary responsibility to see that their employees' retirement funds are safe. IRAs may have more investment choices. On the other hand, investments in a 401(k) may have lower fees, because big employers can negotiate lower fees on mutual funds and other investments. Lastly (and this is very important if you are between the ages of 55 and 60) you can withdraw from a 401(k) without penalty if you separate from service (retire, quit, etc.) in the year you turn 55 or after. But you can't withdraw without penalty from an IRA until you are 59-1/2. If you leave service between the age of 55 and 59-1/2, rolling over a 401(k) into an IRA could cause you to pay a penalty on subsequent withdrawals that would have been penalty-free.

2. Severance pay is considered "Earned income" and your employer should withhold FICA and Medicare tax. That means it is also considered "compensation" for purposes of contributing to an IRA. However, your overall maximum contribution is $7000 to all IRAs, not $7000 to each IRA. The only way to contribute more than $7000 would be to make use of the 457 Deferred Comp plan.

3. A conversion is a rollover, not a contribution. When you take a withdrawal from plan A, you have 60 days to deposit it to plan B in order for it to be considered a rollover instead of regular withdrawal that is subject to tax. Contributions are completely separate. You have until the tax deadline (generally April 15, 2022) to make an IRA contribution for the 2021 tax year. However, if you make a late contribution, make sure you designate it properly with the IRS custodian. If it gets incorrectly recorded as a 2022 contribution, you may be unable to reverse it, and you would be subject to a penalty if you don't have compensation from working in 2022.

4. You can contribute to an IRA (traditional or Roth) as long as you have taxable compensation earned from working. The fact that you have "declared retirement" with one employer or with the social security administration does not change this fact. But you must have compensation from working. Your severance will be considered compensation for 2021. For 2022 and the future, you would need to be working at some kind of job to continue to contribute.

Your overall contribution limit to all IRAs is $7000, if you have a pre-tax and a Roth IRA they do NOT have separate limits.

5. A conversion is a type of rollover. Generally, a direct rollover is best, where the funds are sent directly from one plan to the other. There are fewer risks that way. If you take a withdrawal (where you get the check or direct deposit) you have 60 days in which you can either, roll the money over into a different qualified plan, or return it to the original plan. The exact date of the withdrawal doesn't matter, just the 60 day limit. If you don't put the money into a qualified plan (either a new plan or return to the original plan) the withdrawal becomes taxable.

Also be careful when doing a Roth conversion that you convert the entire amount, or make other arrangements to pay the taxes. For example, suppose you withdraw $10,000 and deposit $7,000 into the Roth IRA, keeping $3,000 for taxes. That will be treated as a $7,000 conversion and a $3,000 taxable withdrawal. If you did a direct rollover of $10,000 and it was a Roth conversion, you would have to come up with the tax money from another source.

Also also, don't wait until 12/31 to initiate your rollover. Most trustees take a few days to process the paperwork, and if you initiate a withdrawal on 12/31 but it is not issued until 1/3, it will be 2022 withdrawal no matter what you plan was supposed to be. Initiate the withdrawal early enough to allow for 3-4 business days plus extra delays for the holidays.