Comparing The Various Retirement Account Types

The world of the Individual Retirement Account or IRA is about as complicated as trying to figure out who you’re related to at a large family reunion.  There can be a hundred people at the gathering and everyone is family, but only a handful can tell you how everyone is related.  Today I will endeavor to be your guide and help you navigate the world of IRA’s.  Well…perhaps just a slice of this world.  

Traditional, Roth, 401k, Roth 401k, 403b, Roth 403b, SEP, Oh my!

Just like you couldn’t possibly remember everyone’s name at a 100 people plus gathering (unless you’re a memory genius) I will not try to bog you down with details you don’t need to know.  For that there is Wikipedia.  Let’s just get to the nitty-gritty of things.  Traditional and Roth IRAs, 401k, 403b, and Simplified Employee Pension (SEP) plans, are ALL retirement plans.  They are all accounts established either for a person (by an employer, e.g.) or by a person (self-employed or doing it alone as a supplement to other retirement accounts, e.g.) and held by a custodian or trustee.  Despite there being several “types” of retirement plans, there are only two ways these accounts are funded:  With money that has not yet been taxed (pre-tax) OR with money that has already been tax.  This is important to note.  See the chart below:

Retirement Plan “Type”	With Tax-Deferred $	With After-Tax $
Traditional IRA	Yes	No
Roth IRA	No	Yes
401k	Yes	No
403b	Yes	No
Roth 401k	No	Yes
Roth 403b	No	Yes
SEP IRA	Yes	No

*Notice the key word is “Roth.”  All “Roth” IRAs are funded with after-tax income.

Some Other Key Considerations

If the retirement plan account is established for you by your employer, you may have little to no input whatsoever as to how to grow the principal in the account.  In other words, investing activities with your principal in an employee sponsored retirement plan may be limited or not up to you at all!  Check with your employer.  And even if you have some or full control on what investments to purchase, some custodians restrict the types of assets you can buy.  Whoa.  Confusing isn’t it?

Here’s what you need to know.  First, if you have a retirement plan, what type of plan is it (see above table for examples)?  Second, is the plan employer sponsored or did you set it up yourself?  Third, are investing activities completely sponsored directed, some “self-direction,” or completely self-directed?  Fourth and final, if there is some path to full self-direction, then what types of assets will your custodian allow you to purchase?  See the table below for a visual:

Type	Employer Sponsored	Self-Sponsored	Employer/ Advisor Directed	Partly Self-Directed	Self-Directed	Traditional Investments Only	Traditional & Alternative Investments

What if I don’t have a Self-Directed IRA?

You can open a new self-directed IRA account at any time.  The process for this is simple.  Find an IRA company or entity that allows investments in alternative assets.  An example of one is IRA Services Trust Company. See: Eric Golub's Guest Author Post.

To fund this new account, you will need to fill out a “Transfer Authorization” form.   You cannot personally direct your prior IRA custodian to send funds to a new IRA company.  Your current IRA custodian must receive a request from another entity.  The “Transfer Authorization” form instructs and gives consent to request funds from a current custodian on your behalf by a new custodian.  One last bit about this.  When opening up your new self-directed IRA, make sure you open the right “type.”  For instance, if you currently have a Roth IRA with a brokerage at a bank, then open up a Roth IRA with a new (self-directed) custodian.  This is an apples-to-apples transfer, so to speak.  Going from a Traditional IRA (pre-tax) to a Roth IRA (after-tax) would be considered a conversion and also a taxable event.  This can be done of course, but be prepared for the tax consequences.

The Problem with the 401(k)

Blogger, Mr. Retire By 40, http://retireby40.org/ recently posted about the problems with the 401(k).  There are two bulleted points in particular that he mentioned that I'd like to highlight:

1. Poor investment selections in many 401(k) plans
2. Employees lack the expertise to invest their 401(k) plan wisely 

In effect, Mr. Retire By 40 makes the case for a failing 401(k) system altogether, and I wholeheartedly agree with him.  But this is not why I am focusing on these two (out of the many) systemic problems with the 401(k).

I am here to share an innovation and happening with respect to the 401(k).  Out today was an interesting showcase article on Yahoo Finance: Start-up Wants to Overhaul...  There is now a company that will take over (manage) your 401(k) investing planning for you, for a small fee of course.  Bloom.com models in some ways the investing platform that the likes of Wealthfront.com or Betterment.com utilize.  The services all of these automated, and passive investing online companies offer, have been falsely and negatively labeled by their more expensive competition as, "robo-advisors."

There are so many players out there vying for a share of everyone's retirement account money.  I can see how it can be both exciting and confusing for a newbie investor.  That's why I'm here!


Questions/Comments?  Please Post.