First, see Roth IRA. The main difference between a Roth IRA and a traditional IRA is that you pay taxes up front on a Roth, whereas you are not taxed on your savings with a traditional IRA until you withdraw it.
This is great for those whose tax rates are lower now than they will be in the future, such as recent college grads. But let's say you've already put money into a traditional IRA and want to convert it to a Roth IRA because there are no income or contribution limits for conversions.
Called a backdoor Roth IRA, the only hitch is the amount you transfer will be considered income that might put you in a higher tax bracket just for that year. And you can only do one backdoor Roth IRA conversion per year.
Let's say you are under 50 and have $200,000 in your traditional IRA account pre-tax. So you decide to open a Roth IRA and transfer $50,000 to it. You won't have to worry about the $5,500 per year contribution limit, nor the income limit for singles or married couples. However, since these are converted funds and not contributions, you will have to wait five years to be able to have free access to your funds. You will also have to add $50,000 to your gross income on your tax return. You might want to look before you leap with your tax adviser.
Related or Semi-related Video
Finance: What is a 401(k)?51 Views
Finance a la shmoop... what is a 401k plan? okay say it with me tax deferred savings
that's it it's really not all that complex for the fancy numbers there all [Complex formula scribbles]
right well when you make money at work you get to defer the tax that you'll pay
on your income or earnings to be paid much later in life and you get to invest
that dough and let it ride tax-free until you take it out of your 401k plan [Money coming out of deferred savings piggy bank]
brokerage account and then at that point well you'll pay ordinary income tax on
your gains well the 401k was a part of the tax code
that was put into motion in the 1980s as the government began to painfully
realize that Social Security wasn't all that secure and that a whole generation
of people who had paid money into Social Security wouldn't get anything back so [People protesting outside the white house]
the government opened the door and made it easy or at least easier for the semi
wealthier masses to save money for their retirement and this was a new idea at
the time a whole new concept like a flying car before then it was mama [Man talking and flying car goes by a window]
corporation who managed the pension money for her employees you know that
sucking off the corporate teat and all that stuff well it fostered a sense of
long-term lifetime loyalty to the company and was all just very you know
IBM like a born in pinstriped blue diapers IBM employee with a hard loyal [Baby boy playing with a flashing rattle]
workforce working away there toiling in the IBM salt mines for 35 years
then retiring at 60 and having smoked a lot dying at age 65 and then that was
all she wrote well that was then this is now it's a different era different
financial pressures so companies don't generally offer pensions today and they
don't generally manage them themselves because the cost of buying real talent
like people who consistently beat the stock market in good times and
bad managing that 401k money is astronomically expensive and generally [Boxing gloves punching the stock market]
speaking corporations can't afford to pay those people nine times whatever
the CEO makes so companies generally contribute some amount of money to a
401k and then they leave it up to the employees to figure out how they want to
invest their retirement savings on their own and that's a good thing most of the
time and you know hopefully it's there when they want to go take it out and
they need the money when they're old and decrepit like like I'm getting...
Up Next
What is a pension? Pensions are just retirement plans. Employers provide them and pay into funds as an investment for their employees. Once employe...
What do you need to retire? Retirement - think: 401k, pension fund, IRA, roth IRA, etc. All of these savings socked away while you worked hard are...