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IRA Rollover and SEP-IRA Accounts
How they Work, What they're For, and Pitfalls.

Update: This is a quite old web page, but as of April 2002 I've updated it after a consultation with a Vanguard retirement account expert. He tells me that after 6 months of explaining this every day he started to feel comfortable that he understood it. Obviously he was exaggerating, but our government has a lot to answer for.

Introduction

I found it surprisingly hard set up a rollover IRA. Also, I ran into some fiendish traps with SEP-IRAs. So, despite my relative lack of expertise, I've written this snippet about rollover IRAs and SEP-IRAs. Do not take what I say as an authority. Confirm everything, preferably with several sources. I found that even accountants and mutual fund advisors gave me conflicting advice. Please don't write asking me to explain further or advise on financial topics. I don't know any more, and I really get too much email to handle inquiries appropriately.

Needless to say, the US retirement investment system is in awful shape. Since ours is a democracy, albeit a somewhat corrupt democracy, we have only ourselves to blame. We will suffer big time for our sins.

Rollover IRA

A rollover IRA is an investment tool for consolidating a number of tax-deferred investments. It's a place to "park" pre-tax investments until retirement. You move pre-tax investments into a rollover IRA directly -- you never take anything in cash. With our horrid national retirement investment scheme, and modern job migration, we all end up with many different retirement investments. A couple could have a dozen or more, each with one or more investment mechanisms. It would be easy to end up with 20 or more separate mutual funds, not to mention non tax-deferred investments. Clearly, even with Intuit's semi-wretched finance software, that's unmanageable. A rollover IRA can allow us to end up with only a few mutual funds to track.

Setting up the first rollover IRA account is the hardest step. Often times there's a chicken and egg problem. Your pension fund holder wants an account to transfer money too, but you can't set up the account until the money is in place. (As seen below, I think there's an advantage to making this first rollover IRA account a money-market fund). Each situation will be different. The big mutual fund people will walk you through the particular steps you need to follow (I use Vanguard, I'll use them as an example). You may not get much help from whoever is holding your investment currently, since they're losing the money!

Once you have one rollover IRA setup, the rest is relatively easy. Vanguard will setup new funds easily, and you can move monies between rollover IRA accounts to your heart's content (but remember, someday you have to pay taxes, and the accounting is going to be hideous).

I used to write here that one should not mix a rollover IRA with money from an employer SEP (self-employment) IRA. I've since been told that as of March 2002 this is ok, but that book-keeping is simpler if SEP funds are kept in their own account. The tax treatments are the same (pay taxes as regular income on post-retirement distributions) either way, but if you keep the accounts separate it's easier to demonstrate to the IRS (for example) that your SEP contributions were made and were within the maximal limits.  If you close out a SEP-IRA keep the old records for the IRS, but I would probably then move the money into my rollover-IRA.

One should NOT make a post-tax IRA contribution (max $2000/year as of 4/02) into a fund (IRA-rollover or SEP-IRA) that contains pre-tax money. You can legally do it, but the tax treatments are different. Distributions arising from the post-tax money would not be taxed, but the pre-tax money would be taxed as income. Good luck ever figuring this out. Many people say that if you have made this mistake, and the amounts of post-tax money are relatively small, you should just pay the extra taxes and forget about it. Consider it your way of funding the deficit.

Annuities are odd. I still haven't figured out if they can go into a rollover IRA. I have a very small annuity I tried once to rollover, but the insurance company that holds it basically stonewalled. I'll try again later. Some experts say that if you want to make the (<$2000/year) post-tax personal IRA contribution, and don't want to deal with yet another fund to hold it, you should use an annuity

If you have a significant amount of money to transfer, you may not want to transfer it to a stock (equity) fund all at once. You may want to "dollar cost average". On the other hand, the work of moving money piecemeal into a rollover IRA can draining. I think the best way is to setup a rollover IRA money market account with the mutual fund company you want to use (say, Vanguard). Then move everything en masse into the money market fund. Then set up an automatic funds transfer from the rollover IRA money market fund into the equity fund you want to use.

SEP (self-employment) IRAs

A SEP-IRA is a good way for self-employed persons to make pre-tax contributions. If you're self-employed, you can put in up to 13% or so of your income( more after 2002). If you put in more than 13% you may be able to shift the contributions to the next tax year. However you have the shift made before the tax filing deadline. If you make the shift before the deadline you only lose your dividends. If you make the shift after the deadline you keep the dividends but lose 6% of the value of the excess contribution as a tax penalty. I got hit with that penalty after an unwitting excess contribution. I love our government.

Beware. If you get a W2 for your work, you are not self-employed. If you get a 1099 or K1, you are self-employed. If you receive a W2, you have have no avenue for tax-deferred retirement except the rather limited straight IRA option, even if you have no benefits or pension plans! Grrr. Remember, we voted for these @# politicians.

If you make a SEP contribution be sure that the receiving fund knows that these are pre-tax dollars, not a post-tax contribution. This can be confusing, and I'm not certain what the correct procedure is. In one case Vanguard had to correct the contribution for me.


Descriptors
Confidence (1 to 3): 2. Date Created: 2/19/97. Last Revised: 4/02/2002. Expires: . Language: english. Domain: .us. ID: 6. Topic: world. Subtopic: . Keywords: finance, investment, tax, retirement, account; self-employment; SEP; roll-over; retirement.


Author: John G. Faughnan.  The views and opinions expressed in this page are strictly those of the page author. Pages are updated on an irregular schedule; suggestions/fixes are welcome but they may take weeks to months to be incorporated. I reserve copyright except where noted, if you want to repost or quote a page just ask. Anyone may freely link to anything on this site and print any page; no permission is needed for linking,  printing, or distributing printed copies.