Podcast Episode - Suze School: The Language of Money in Retirement Accounts

On this Suze School, we get a lesson on the language of money in retirement accounts.  We’ll learn about rollovers, transfers and conversions.   Knowing the meaning of these words may keep you from making a mistake, keep you from paying taxes when you don't have to and keep you from getting into a penalty situation.

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Podcast Transcript:

February 25th, 2024. Welcome everybody to the Women and Money podcast as well as everybody smart enough to listen, Suze O, here and today is Suze School. So that means get out your Suze notebooks or any paper that you can write things down on because, you know, we do have a tremendous amount of podcasts that I've done.

I think we're well over 500 now and sometimes you hear something and it pertains to you or it doesn't pertain to you and then you think, ok, and you're just listening and then all of a sudden you really need to know what it is that I talked about on this podcast and you go back to the podcast and you can't find them and then it becomes a mess. So it's just easier if you keep a notebook with things that probably you will need to know one day.

Now, listen, I know, I know that I said last week that I would be covering the topic, married filling separately.

And some of you were so excited about that, but I decided, no, I'm not going to do that right now because really that topic applies to so few of you.

And there's another topic that I want to do today that I know applies to almost every single one of you out there. So I've changed my mind. I'm a Gemini. I can do that. So, are you ready? Let's begin.

Have any of you ever taken a trip to a foreign country where they speak a language other than your language? Let's say it's English. So you learn a few words or you go over there and you learn a few words such as hello. Thank you. I need the check. Whatever it may be. Is it to the left? Is it to the right? Where's the bathroom? And it's those few words that get you by. You don't need to learn the entire language to have a good time.

You don't need to be able to speak it fluently to have a great time. Just a few words to get you by. Well, when it comes to money, I have to tell you the same is exactly true.

You don't need to know the entire terminology that is used within the financial world. It is extensive, it is confusing and for most of you, it is irrelevant.

You don't need to know that much, but you do need to know, especially when it comes to your retirement accounts that you have never paid taxes on traditional retirement accounts. Just a few words, because it is knowing that these few words that can keep you from making a mistake, that can keep you from paying taxes when you don't need to pay taxes, that can keep you from getting yourself into a penalty situation.

And the reason that I'm still focusing on retirement accounts is, let's be honest, the majority of everybody out there has a retirement account, whether it's an IRA, doesn't matter whether it's traditional or Roth, whether it's a 401k 403b or TSP, doesn't matter if it's traditional or Roth, if you're even an individual or self employed, you have a SEP IRA, an individual 401k, possibly a pension plan. All of us have on some level at some time in our lives, retirement plans. And the truth of the matter is the bulk of the money that we have saved for later on in the future happens to be, in most cases in a retirement plan that is taxable.

So there are just a few words that all of you need to know. And the reason that I'm doing this podcast is many of you write me emails and you tell me about your situation and you tell me that you've done this, you've done that, you've done that, you've done this and I'm so confused because I don't really understand what you've done because the words that you are using to describe the action that you've taken that you want advice on don't fit to the situation that you've described. Are you ready? And let's begin. First of all, write down the words rollover transfer and conversion. Those are terms that I really want us to understand today and how they work.

Before I begin with all of this, if you have a TSP a thrift savings plan, what I'm about to say does not necessarily apply to you. Right after I have done this, I will then tell you what these words mean to you. Also, I just have to say that the majority of this is for people who have money in traditional retirement accounts, pre-tax retirement accounts. Some of it will apply to those of you who have Roth retirement accounts, but obviously Roth retirement accounts, in most cases, you don't owe taxes on them. So therefore, just keep that in mind.

So let's start with our rollover.

A rollover is when you have a specific type of employer sponsored plan such as a 401k or 403b and you either are leaving that place of employment or you have retired, whatever it may be, and you want to roll over, you want to change a 401k that is with your employer. You are rolling it over to a new custodian or trustee. They're both the same... at a new firm, whether it's a brokerage firm, a discount brokerage firm, a bank, a credit union, an insurance company, anywhere that you want to roll it over to.

So you are changing the types of accounts that your money happens to be in.

So you are rolling it over from a 401k to an IRA. And that's known at that point as an IRA rollover because it came from an employer sponsored plan known as a 401k or 403b.

And what's important for you to understand about that is that there are two different ways for you to do a rollover.

You can do a direct rollover or an indirect rollover.

A direct rollover is when you are ready to change money from your employer sponsored plan to an individual retirement account where you set up an IRA rollover, you set it up at either a brokerage firm, a discount brokerage firm, wherever you want to set it up, you can even do it at a bank or a credit union and you open up an IRA account there

And you ask your financial advisor to contact your ex-employer to request what's known as a custodian to custodian transfer. It's also known as a trustee to trustee transfer. And that means that your ex-employer is going to send directly to your IRA the money that is in your 401k or 403b.

You do not touch that money at all. It goes directly from your ex-employer to your new custodian where your IRA rollover is going to be located just that simple. When you do that, if you have $100,000 in your 401k, then automatically $100,000 is going to end up in your IRA rollover. Now, on your documents, it's not going to say IRA rollover. It's just going to say IRA. But in essence, you are rolling over the money from your employer sponsored plan into a different type of plan known as an individual retirement account. Now, remember everybody, this is also true, whether you have a traditional account or a Roth account

An indirect rollover. This is something that nine out of 10 of you will never ever want to do. Especially if you have a pre-tax retirement account, an indirect rollover is where your ex-employer might ask you, do you want them to send you a check or do you want them to send it directly to your new custodian? You always want choose sending it directly to your new custodian. However, some of you may decide, yes, please send me the check.

So now it will not go directly to the custodian. It goes to you if they and listen to me closely now, if they send you a check and that check is made payable to you and this is coming from a traditional retirement account, what will happen is they will absolutely withhold 20% for taxes.

So if you have $100,000 in your traditional 401k and they send you a check, made payable to you, you are only going to get a check for $80,000. You then will have 60 days from the date of that check to put it in, yourself, into an IRA at whatever firm you opened up an IRA with. So you are indirectly rolling over the money that was in your traditional 401k into an IRA because it's not going straight to the IRA. It's going to you first. Here is the danger if you do that.

Number one, if you wait 61 days or more to do that indirect rollover with that $80,000. In this example, you are going to owe ordinary income taxes on that $80,000 and possibly a 10% penalty if you're not 59.5 years of age or older,

Something you need to think about. An exception to that would be that you're 55 years of age or older in the year you left service. Ok, you won't have to pay the 10% federal tax penalty, but you most certainly will have to pay ordinary income tax on that money.

But here's the other problem, let's say you've been great and you get this money and within that 60 day period of time you have now put it in your IRA rollover account.

So fine, you think you're doing ok. You are not, because the $20,000 that your ex-employer withheld for taxes is part of your taxable situation.

So you are going to have to come up with $20,000 out of your own pocket to put into your IRA rollover to make sure that there's $100,000 in that IRA rollover within that 60 day limit. Otherwise you are going to owe taxes, on that $20,000 that they withheld to pay taxes.

You don't want to get yourself in that situation. It makes absolutely no sense whatsoever. Almost 100% of the time, you only want to do a direct rollover. You do not want to do an indirect rollover. However, there are some times when an employer refuses to do a custodian to custodian or trustee to trustee transfer. Don't ask me why, but they just refuse to do it. And what they will do instead is that they will send to you a check from your 401k. And they'll send it to you, but this time the check will be made payable to your new account wherever you have opened up your IRA. And if they do that, then don't worry about it because chances are they have not withheld the 20 percent mandatory withholding tax. So it's okay if they do that. It's better if they did it directly so you didn't have to go and then take the check and get it into the account within 60 days. But there are some employers that just refuse to do custodian to custodian rollovers. So just to be clear, if you're one of those people and you get a check made payable to your new financial institution, your new account, don't worry about it. Because again, they should not have withheld the 20 percent mandatory withholding.

So if you have $100,000 in your 401k and now you want to do an IRA rollover with it.But your ex employer sends you a check made out to your new financial institution. Chances are that check is going to be for $100,000 and you will just have to take that check and make sure you immediately deposit it within that 60 day period. It should be really right away, everybody, so you don't forget about it, into your new account. Just that simple. So, very different than when your employer makes the checkout payable to you, they then have to do the 20 percent mandatory withholding versus your ex employer makes the checkout to your new financial institution. So even though that is an indirect rollover, you're not going to have the 20 percent withholding withheld from your payment. Alright, I hope you're clear on everything I just said.

Next, transfer. A transfer is not a rollover everybody.

A transfer is when you go from an IRA account, maybe at one brokerage firm to another IRA account at another brokerage firm, you are not changing the types of accounts, maybe it's going from one 401k at an employer that you left to your new employer. You're not changing the type of an account. It is again, a 401k is different than an IRA.

An IRA is not different than another IRA.

So when you are going from one type of IRA to another, to the exact same type of IRA at a different institution that is known as a transfer. And in that situation, you also want it to go from custodian to custodian.

If you have an IRA, that is a traditional IRA, you legally are allowed to withdraw money from it if you want to and you have to put it back within the 60 days. Some people do that because they really need money. They're short on something. They know money is coming in within 60 days for them. So they literally take money out of their IRA, use it for what they need to when other money comes in, they replace it within those 60 days.

That also is known as a roll over where you're rolling over money to yourself and putting it back in, you cannot do more than one indirect rollover a year.

So whether it's from a 401k and you indirectly have money sent to you and then you put into an IRA or you have a traditional IRA where you have taken money out and you are putting it back in within 60 days. You cannot do that more than once in a 12 month period of time

Notice I said a 12 month period of time, I did not say annually.

So if you do it, once you cannot do it again, from any account for another 12 months. When it comes to transferring your accounts, you can do it as many times as you want in a year when you transfer from one IRA to another IRA. And now you want to transfer it to another IRA. You can do that as many times as you want.

You can also do a direct 401k rollover to an IRA as many times as you want.

So again, when you transfer something. There's no limits on how many times you can do that provided. They are trustee to trustee or custodian to custodian transfers on rollovers. There's no limit providing. It is a direct rollover but indirect rollovers, any 60 day distribution that you get is only allowed once in a twelvemonth period of time across all the accounts that you have.

Next - a conversion. A conversion is when you are changing, you are converting a pre-tax retirement account into an after tax retirement account. In most cases, you can convert a traditional 401k where you have never paid taxes on that money to a Roth 401k. That is a conversion. A conversion is when you go from a traditional IRA that you have never paid taxes on to a Roth IRA. When you convert, it doesn't matter if it's from a traditional 401k to a Roth 401k. A traditional 403b to a Roth 403b. A traditional IRA to a Roth IRA. You will owe taxes on any amount of money that you converted in the year that you converted.

Do not get confused that once you retire from some place and you are taking a 401k and now you are thinking you are doing a rollover to an IRA at another brokerage firm or wherever you're doing it and you put it into a Roth IRA. It is going to be 100% taxable to you on the amount that you did that that is not a rollover. That is a conversion again, do not confuse it.

A 401k to an IRA rollover. Pre-tax is a rollover. A Roth 401k to a Roth IRA is a rollover. In a traditional IRA, meaning pre tax a traditional IRA to another traditional IRA at a different custodian is a transfer. A traditional IRA to a Roth IRA is a conversion. They are very, very, very different and many of you are getting these confused and ending up owing taxes when you didn't think you needed to.

One other thing about a backdoor Roth IRA, since so many of you are interested in it.

To do a backdoor Roth IRA, you fund an IRA that is non deductible and you convert it to a Roth IRA, you don't transfer it, you don't do a rollover. That is a conversion as well.

Let's just quickly switch to those of you who have a thrift savings plan. You're a federal employee or you work for the armed services. Your retirement plan is known as a thrift savings plan or a TSP.

For you, a transfer means when you send money directly from a traditional TSP to your IRA account. So that is a transfer for you. If you're not TSP people, that was a rollover for you, a transfer for the TSP people mean you are simply sending money directly from where you have it to your IRA account. It does not go to you

A rollover, however, within a traditional TSP means they send you a check directly and you have 60 days to get it into an IRA. They will automatically also withhold 20% and send it to the IRS. If you are in the armed forces or work for the federal government,you never, ever, ever want to do a rollover of any kind, you only want to do a transfer.

So again, for you, the terminology is different than for those who aren't part of the armed forces or work for the federal government. T hat is what you need to know. That is the language of money when it comes to retirement accounts. Now, you may need to listen to this again over and over again. You may need to write the notes down over, over again in your Suze notebook. If I were you, what I would be doing is I would be writing down the type of retirement account I have and then I would be applying the terminology that I just gave you to the types of retirement accounts you have and what you intend to do with it. So that is the Suze school for today.

Until Thursday when Miss Travis joins us again for another Ask KT and Suze Anything. Remember, there's only one thing that you need to know when it comes to your money and it is this people first, then money, then things. So you just stay safe and if you do all that, oh I promise you, you will be unstoppable.