Distributions of any pretax (deductible) contributions and earnings are taxed as ordinary income. However, distributions before 59½ may be subject to a 10% early withdrawal penalty, in addition to regular income taxes, unless you qualify for a penalty exception (see next question below for possible penalty exceptions).
Distributions of after-tax contributions (non-deductible) aren’t subject to taxes or penalties, since you’ve already paid taxes on those dollars. However, if you have pretax and after-tax assets in your traditional IRA(s), your distribution will include a mix of pretax and after-tax dollars based on the percentage each represents for your total IRA account value. This is known as the pro rata rule.
To determine the percentage of your distribution that’s made up of pretax dollars (and subject to taxes), the IRS looks at all your traditional IRAs (including SEP and SIMPLE IRAs), not just the IRA you took the distribution from.
Per the IRS, the 10% penalty is waived for early IRA distributions if you:
- Inherited the IRA after the original account owner died.
- Are disabled or terminally ill.
- Take distributions in substantially equal payments over your life expectancy.
- Have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.
- Use the distribution to pay for medical insurance premiums due to unemployment.
- Use the distribution for qualified higher education expenses.
- Use the distribution to build, buy or rebuild a first home (up to $10,000).
- Use the distribution to pay for expenses related to the birth or adoption of a child (up to $5,000 taken within one year following the event).
- Are a reservist called to active duty after Sept. 11, 2001.
- Use the distribution to satisfy an IRS levy.
- Are impacted by a qualified disaster and take the distribution within the required timeframe (up to $22,000 lifetime limit).
One of the main differences is the way contributions and withdrawals are taxed. Traditional IRA contributions are generally made with pre-tax dollars, any earnings growth is tax deferred and future withdrawals are taxed like income. Roth IRA contributions are made with after-tax dollars and future, qualified withdrawals are tax free.
Another difference is required withdrawals. If you have a traditional IRA, the IRS requires you to withdraw a minimum amount each year when you reach 73, known as a required minimum distribution (RMD). A Roth IRA has no RMDs.
See Traditional IRA vs. Roth IRA for more details.
A 401(k) plan through your employer is designed to allow you to contribute a percentage of your salary for retirement savings. Employer plans may offer a traditional 401(k) and a Roth 401(k) for employees. Like an IRA, a traditional 401(k) is funded with pre-tax dollars and distributions are taxed as ordinary income, while a Roth 401(k) is funded with after-tax dollars with the potential for tax free withdrawals in the future.
With a 401(k), your employer makes several decisions on your behalf — where your account is held, when you’re eligible to contribute, what investment options and services are available to you, and when you can take distributions from your account, to name a few. 401(k) plans are generally less expensive than an IRA and can offer certain benefits that are unavailable to IRAs, such as employer matches, the ability to borrow against your assets, the ability to take penalty-free withdrawals beginning at age 55 if you meet certain criteria and the ability to delay RMDs while still working.
A traditional IRA is an individual account you contribute to and manage. It offers you more control and choice over where and how your contributions are invested as well as when you can access your funds. These accounts are not tied to your employer and are transferable between institutions at any time.
If you want to maximize your retirement savings, you can contribute up to annual limits for your 401(k) and a traditional IRA as long you meet the eligibility requirements.
You generally must meet two criteria to be able to roll over your employer retirement plan to an IRA:
- Your plan must allow you to take a distribution.
- The distribution must be eligible to be rolled over. Certain distributions, such as RMDs and hardship distributions, are not eligible.
Additionally, Roth 401(k) assets may only be rolled over to a Roth IRA. Pre-tax 401(k) assets can be rolled over to a traditional or a Roth IRA. But, if you roll over pre-tax 401(k) assets to a Roth IRA, it’s considered a Roth conversion, and the amount that's rolled over will be taxed.
It’s also important to know that there are differences between employer plans and IRAs. Make sure you understand your options before rolling over. A financial advisor can also help you determine whether rolling over makes sense for you.
Yes, you can transfer your IRA to another provider at any time without tax consequences or tax reporting as long as the assets move directly from your current IRA provider to your new IRA provider.
To move an existing IRA to Edward Jones, contact a financial advisor to help you determine the method best suited to your needs.