Is Roth IRA Investing Different?

Where to put your retirement money is always a problem. There is allocation, diversification and risk to consider. Expenses and fees, performance and tenure also come into play. If that is the case, is investing with a Roth IRA that much different than with a Traditional IRA?

Yes and No.

In a traditional IRA, the money you invest is done so on a tax deferred basis. Money you invest in a Roth IRA has been taxed, leaving only your earnings on those investments taxable at the date of your retirement. Because you paid taxes on the money you have put in, it is essentially yours to remove at any time. But once you do, although you will not face the tax or penalties associated with withdrawing invested dollars from a Traditional IRA, it still hampers the overall investment.

In both plans, the money is set aside (invested) for the future. It is not meant to be taken out before you retire - for any reason. Doing so will take potential growth off the table and this will change any projections you may have made based on assumed growth and potential retirement distributions, no matter how small.

The inside workings of these two types of IRAs is essentially the same. Although Roth 401(k) plans have surfaced recently, Roth IRAs have gained acceptance as a way for folks to continue to invest for their future in lieu of pensions and 401(k) plans. This makes the Roth IRA perfect for the investor who has maxed out every other form of tax-deferred investment.

Which makes the Roth IRA not so ideal for those looking to pay less taxes now by deferring those taxes until a time when their income will be less (most retirement planners will point to an annual income post-work of 75% of your current/future earnings as a benchmark for your retirement plan's success). Using a Roth may seem attractive at first glance, but unless you are swimming in invest-able dollars, it might be wise to keep the tax deferred plans fully funded first.

If you have, your current fund family, broker or bank will be a good first place to look. If you do, you should have a working knowledge of how to solve those nagging allocation and diversification problems (be careful to avoid buying funds that have similar investment goals in both your Traditional IRA and your Roth IRA - although they seem different, they still belong to you), fund expenses and fees (I'm assuming that if you have already committed to a group of funds in your tax-deferred accounts, they are already inexpensive compared to their peer group and in some instances, to the benchmark) and the overall performance of the offerings (look long-term, preferably longer than five years).

Once that is accomplished, you can invest in a Roth IRA with exactly the same discipline you would any other investment. You should understand your objectives, have a relatively decent grasp on your own investing behaviors and tolerance for risk, and do so with an eye on investing as inexpensively as possible.

Paul Petillo is the Managing Editor of BlueCollarDollar.com

Retirement Planning: Rollovers and Other 401(k) Considerations

While the 401(k) plan you have access to at your place of employment is a a "better-than-nothing" retirement plan doesn't mean that you should ignore the benefits of investing for your future.

There are three basic problems with the retirement plan (and how you use it) known as the 401(k). You can read the full article here.

What to keep in mind about your 401(k) plan and rollovers:

If you have a 401(k) plan use it and if possible, use it to its fullest.

Get your financial house in order while you are working, especially if you have only been in your 401(k) plan for less than fifteen years.

Rollover your old 401(k) into a Traditional IRA within 60 days and be careful with the paperwork.

If you have more money to invest, open a Roth as well.

Why Investors Do What They Do: Mental Accounting

Many of us can rattle off the balance in our set-aside accounts, the small stashes of money we allot for some special purpose. These accounts, whether they be for a down payment on a house or a vacation have been designated for something and when you mentally account for this money, you put a barrier around your access to it.

These are essentially illiquid accounts - at least in your mind. This type of thinking and the ability to strictly categorize is a special talent that many of us have and some of us need to work on. If you are able to keep even so much as a general budget of your household, you are probably using this kind of separation technique to make sure ends meet and the other accounts you have set-aside do not become victims of a small loan.

Retirement accounts, even those with restrictions on how you may access the principal amount you have contributed (penalties for early withdrawal, tax consequences) are good examples of this kind of behavior. Setting aside money to grow and adding to it on a regular basis is mental accounting. These kinds of accounts are often of the traditional 401(k) and IRA variety. It should be noted that one of the major selling points of the Roth IRA and Roth 401(k) is the access you have to your principal.

Mental accounting really becomes a problem, almost without noticing it has, is when you separate different elements of an investment. Some are willing to pay higher fund expenses in return for a riskier fund that has done well in the past. This is a cost trade-off that you make using this type of accounting error. Another example might be a bond fund that entices investors with a high yield but the underlying investment is losing capital.

(This last example is why there may be a flaw in the thinking that we overload a portfolio with dividend paying investments at the end of our careers. Once we begin drawing down the underlying investments, the dividends will also fall and this will lead to a quicker drain on the account.)

Much of this has to do with our love affair with our investment picks. Only the most hardened among us can engage in the cold-calculations that stock pickers really employ. Listen for the insincerity when a talking head on television begins a conversation about an investment with "we really like this stock...". That is, until something changes.

Mental accountants ignore these warning calls and often miss selling winners when they are winners and even worse, selling losers when they are losers. This throws the whole diversification within a portfolio out of whack. While we are still working, it pays to focus how we bracket our investments. Keep in mind that studies have proven beyond a doubt, bets on long shots increase as the last race approaches.

If you find evidence that an investment has changed, and some suggest that loss aversion plays a role in this type of mental reasoning, you need to reposition your portfolio. This is not as hard as it seems nor does it require as much time as you might think.

It does however require you open your statements when they come each quarter or look at them online once a month. Set-up a Google alert for each underlying investment (a good retirement account should have no more than eight mutual funds and as little stock as possible) or build a sample portfolio at anyone of the sites that provide the free service. At the first hint of doubt, investigate and make a decision on what you should do with the whole of the portfolio as the benchmark, not the performance of the individual holding.

Next up: Diversification

G is for Gross Income - Retirement Planning

We continue our look at some of the important factors of a good retirement plan. This alphabetical look at what you need to know continues with a look at gross income.

In Retirement Planning, G is for Gross Income

There are very few downsides to owning a Roth IRA. Of course there is the tax advantage. After five years, the money can be withdrawn tax-free. Unlike a traditional IRA, all of the withdrawals are taxed at your regular income. (The reason for this difference is based on whether the money was taxed prior to deposit – traditional IRA deposits were a deduction from taxes whereas a Roth IRA is funded with after tax contributions.)

A traditional IRA requires you to take withdraws by age 70 ½ (actually the date is April 1st in the year following your 70 ½ birthday). A Roth does not have any such requirements, allowing you to keep the money invested until you need it – if ever. And that “if ever” allows you to pass the Roth IRA on to your heirs who, although they would be required to take distributions, would find the added income from the inherited Roth IRA would be tax-free.

While there is no guarantee that your Roth IRA will grow without set-backs – what you pick for your investments determines the portfolio’s possibilities, the ability to save more is restricted not only by age but by gross income.

Age and Income

Your contributions before you reach fifty-years-old are limited in both the Roth IRA and the traditional IRA to $5,000. But after fifty, the annual contribution jumps to $6,000 with adjustments being made thereafter based on inflation.

But gross income also plays a role in how much you can contribute. More specifically, modified gross income. If you are single, that income cannot exceed $101,000 and if you are married, filing jointly, the income limit is set at $159,000. Modified gross income is calculated using IRS publication 590 (turn to page 61) and does not include any Roth conversions you may have made in the current tax year.

What if you make too much? It is a nice problem to have but to avoid not investing at all, the IRS allows you to make non-deductible IRA contributions. Conversions have income limits as well ($100,000 a year for individual or joint filers – sorry, married filers filing separately re not allowed to convert). But hold onto the non-deductible IRA until 2010 and convert without penalty.

There are still taxes to be paid on the conversion however but they can be spread over the following years (2011 and 2012).

A is for Asset Allocation

B is for Balance

C is for Continuity

D is for Diversity

E is for (Tracking) Errors

F is for Free-Float