Author Topic: How do the logistics of IRA contributions work?  (Read 3313 times)

xenon5

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How do the logistics of IRA contributions work?
« on: August 19, 2013, 09:58:12 AM »
So I get that the benefit of a traditional IRA is that you don't pay income tax on contributions.  However, exactly how/when do you make this contribution such that the tax isn't taken from you?  What I mean is, do you contribute with money you have in your checking account, then wait for next tax season to get back the income tax you paid on that contribution as part of your refund?  Can the first contribution be money rolled over from a 401(k) (while still employed)?

And can you do a direct deposit to such an account to avoid the income tax on that money ever being taken from you?

Dr. A

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Re: How do the logistics of IRA contributions work?
« Reply #1 on: August 19, 2013, 10:21:36 AM »
1) You will make a contribution directly from a bank account, and most banks/brokerages that provide IRAs can take automatic withdrawals on a regular basis. Depending on the bank/brokerage they may be able to set up a direct deposit for this as well (not 100% sure on this one). Regardless...

2) You cannot make pre-tax contributions to an IRA like you can with a 401(k). The only option is to contribute post-tax dollars and then claim a deduction for your contribution on your tax return. This can be done for contributions made up to Tax Day, meaning you can claim a deduction on your 2013 taxes for any contribution made between 1/1/2013 and 4/15/2014.

3) You can open an IRA with a rollover of a 401(k). You can always rollover a 401(k) from a previous employer. Each plan has different rules about a current employee's ability to rollover. A rollover does NOT count as a contribution for tax purposes. You can't deduct it (because it's already pre-tax money), but it also does not count against the contribution limit.

matchewed

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Re: How do the logistics of IRA contributions work?
« Reply #2 on: August 19, 2013, 10:27:00 AM »
I'm not an expert on this but a friend of mine is a freelancer. What he has done is essentially set up an LLC and he is an employee of that LLC. This allows him to contribute pre-tax money to an IRA. That is one way of doing it.

huadpe

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Re: How do the logistics of IRA contributions work?
« Reply #3 on: August 19, 2013, 11:17:39 AM »
So I get that the benefit of a traditional IRA is that you don't pay income tax on contributions.  However, exactly how/when do you make this contribution such that the tax isn't taken from you?  What I mean is, do you contribute with money you have in your checking account, then wait for next tax season to get back the income tax you paid on that contribution as part of your refund?  Can the first contribution be money rolled over from a 401(k) (while still employed)?

And can you do a direct deposit to such an account to avoid the income tax on that money ever being taken from you?

In most cases, you do it with your after tax money and then deduct the contribution on your form 1040, which results in a refund being sent to you (or offsetting taxes owed).

So, suppose I'm going to put $5000 in a traditional IRA, I do this with the money that comes out of my paycheck, which has had taxes withheld from it.  The $5000 results in me having $1250 less in tax owed (assuming 25% bracket), and therefore when I file my tax return in April, my refund will be $1250 bigger.  If you want to see the money now instead of waiting for April, you can ask your employer to reduce your withholding and see a bigger paycheck now, but smaller refund later.

xenon5

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Re: How do the logistics of IRA contributions work?
« Reply #4 on: August 19, 2013, 11:47:07 AM »
Thanks all, it sounds like you covered everything I was wondering.  In that light, is there any reason to open a traditional IRA before I'm either funding 100% of the 401(k) limit, since it can be rolled over anyway, or if I change jobs?  I can understand opening a roth sooner since it can double as an emergency fund and/or first home savings account.  I'm already in the traditional IRA phase out range so I probably don't have a lot of years left for which it's beneficial to do so.

Dr. A

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Re: How do the logistics of IRA contributions work?
« Reply #5 on: August 19, 2013, 02:17:31 PM »
There is basically one major benefit to an IRA vs. a 401(k) (really two sides of a coin). With an IRA, you can pick any mutual fund, stock, ETF, bond, or a number of other investments to put your money in. A 401(k) is limited to the dozen or so mutual funds that your employer has selected. In the typical 401(k) plan, there is a significant fee for the plan and the choices are all high-expense-funds. This arrangement is good for the company administering the plan, and bad for the participants.

That's a general rule however. My company offers a (relatively) awesome 401(k) with a bunch of low-expense funds, a token annual fee, and even allows me to invest half the money directly in individual stocks, so you should definitely check out the details and compare.