An important part of medical education involves learning the vocabulary of the field. Think about how many new words you learned during Gross Anatomy alone! Medical vocabulary involves precise meanings for various words, and patients often don't use them. How many times have we heard a patient say they have “heart pain” instead of chest pain and”kidney pain” instead of flank pain. Stomach and abdomen are interchangeable to many patients but to a doctor, they each have a precise meaning. That's not even discussing the patients with fireballs in the eucharist, blood clogs, vomicking, and dryalysis.
The terminology in the financial world also has precise meanings, and if you want to understand how the financial world really works, it's worthwhile learning them. Not only will it help you understand what is going on, but it will make you look smarter and hopefully you will be taken advantage of less. Let's start with my pet peeve.
Rollover
Besides a command you give your dog, many doctors use the word rollover to describe any time money moves from one place to another. “I rolled over my traditional IRA to a Roth IRA” or “I rolled over my 401(k) to Fidelity.” However, a rollover has a very specific definition. A rollover is when a financial institution sends you a check from a qualified account, like an IRA or 401(k), and within 60 days you deposit that money into another qualified account at a different institution. Starting this year, you can only do one rollover per year. This law is to curb abuses where some people were constantly doing rollovers from one account to another, essentially enjoying the tax-free use of their money for whatever they wanted. However, rollovers are actually pretty rare. I move money around all the time, but I've never actually done a rollover. I generally do transfers, and you should too.
[Update 11/5/2015- I got hammered by readers in the comments section on this one. It turns out even the IRS uses rollover to describe any kind of transfer, whether you take possession of the money or not. It turns out my pet peeve wasn't even real after all. How embarrassing!]
Parenting success is when your 6 year old and your 8 year old volunteer to change the newborn's diaper
Transfer
A transfer is when the financial institution that has custody of your IRA transfers that money into an IRA at another financial institution without you ever getting your greedy paws on it. You can do as many of these as you want in any given year. The main downsides are that the paperwork takes a few minutes of your time, financial institutions tend to screw up transfers from time to time, and your money may be out of the market for a week or two, which obviously can be either bad or good, but since the market generally rises, is usually bad.
Conversion
A conversion is a special kind of transfer (or rollover) where you move money from a traditional IRA or 401(k) into a Roth IRA or Roth 401(k). This is a taxable event (although the tax bill may be zero, as with a Backdoor Roth IRA.)
Recharacterization
A recharacterization is what you do when you realize you really didn't want to contribute or convert to a Roth IRA but instead wanted to contribute to a traditional IRA, or not do a Roth conversion. One common reason to do a recharacterization is when you end up making more than the Roth IRA contribution limit but made a direct (instead of a backdoor) Roth IRA contribution. You have to recharacterize the contribution to a traditional IRA contribution. Some people also do recharacterizations if the market moves against them. For example, if you converted a $5000 IRA to a Roth IRA and invested it in the market, then the market dropped 20%, you could recharacterize the conversion. Then, after 30 days or the next calendar year after the conversion, whichever is later, you could reconvert it. That could save you hundreds of dollars in taxes due on that conversion, since the second conversion is only $4000 instead of $5000.
Contribution
You don't deposit money into retirement accounts, you “contribute” it.
Distribution
You don't withdraw money from retirement accounts, you “take a distribution.”
There are dozens of other financial terms that are worthwhile to learn. Such as the difference between a fee-only and a fee-based adviser. (You pay both fees and commissions to a fee-based adviser.) 12B-1 fees, B shares, emerging markets, index funds, factors, spreads, wash sales, collars, commodities, MLPs….the list goes on and on. Learning all these terms is part of your Continuing Financial Education. The more familiar you are with the precise meanings of the vocabulary of the financial world, the less likely you are to make mistakes and to be taken advantage of.
What do you think? What financial terms do you see your colleagues misusing? Comment below!
Years ago with vanguard you had to fill out an application to transfer funds to them
Now it can be done with a phone call
BTW- they are a tremendous company with great customer service and the lowest of fees
I’m irked when people state they paid “taxes”, but don’t discriminate between capital gains, property, earned income, AMTs, payroll, or estate. This term is used esp. sloppy in the political rhetoric.
Well, technically they are correct as everything you state are taxes. But yes, those taxes do come in lots of flavors at different rates.
Sometimes when people say that lower income people don’t pay taxes, they’re referring to federal income tax, although it’s likely they are paying payroll taxes and sales taxes.
It’s a rollover when an employer sponsored plan is involved. From one plan to another, it’s a rollover. From a plan to a traditional or Roth IRA, it’s a rollover distribution. From a traditional or SEP IRA to a plan, it’s a rollover contribution. From traditional to Roth within the same plan, it’s a in-plan Roth rollover.
I see nothing on the IRS site indicating your definition of a rollover is correct. I do see some loose usage where they call a transfer a “direct rollover” but for their “one rollover a year” rule they are very clear that trustee to trustee transfers don’t count.
https://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Rollovers-of-Retirement-Plan-and-IRA-Distributions
You just have to look in the right places. 🙂
Rollover distribution: https://www.irs.gov/Retirement-Plans/Retirement-Plan-Participant-Notices-Distributions
Rollover contribution: https://www.irs.gov/Retirement-Plans/Verifying-Rollover-Contributions
In-plan Roth rollover: https://www.irs.gov/Retirement-Plans/Designated-Roth-Accounts-In-Plan-Rollovers-to-Designated-Roth-Accounts
P.S. Whether something is a rollover and whether it counts in the one-rollover-per-year rule are two different questions. That IRS link says:
“The one-per year limit does not apply to:
– rollovers from traditional IRAs to Roth IRAs (conversions)
– trustee-to-trustee transfers to another IRA
– IRA-to-plan rollovers
– plan-to-IRA rollovers
– plan-to-plan rollovers”
The last three items are all rollovers but they don’t count in the one-per-year rule.
Thanks for the clarification. Looks like the IRS uses the term “rollover” a lot more generally than I thought they did.
Is there a proper term for the “roll-in”, where one takes traditional IRA funds and moves them to one’s current employer’s 401(k)/403(b) plan? It’s a key move to avoid running afoul of the pro rata rule when doing backdoor Roths.
“Transfer”
I was a resident first half of this year and contributed directly to my Roth IRA as usual, before realizing that my salary might be over Roth IRA limit. So I need to re-characterize it to a newly setup acct.—non-deductible traditional IRA, correct?
I already transferred my Roth 403b into my Roth IRA when I left my residency. Used to have a traditional IRA but closed when I converted all into Roth years ago.
So I can convert IRA back to Roth IRA immediately (backdoor Roth) without “pro-rata” calculation, without any tax, right?
Do I have to do those before end of Dec. 2015?
You also mentioned that Roth IRA gives asset protected space” in most states”—how do I find out my state does or not and how much it’d protect?
Thanks
No, you can’t do it immediately. You have to wait the longer of 30 days or until the next year. Then you can reconvert. It’ll make your 8606 a little complicated, but not bad.
Look your state up here: http://www.assetprotectionbook.com/forum/viewtopic.php?f=142&t=1566
Hi, Linda, I think WCI may have misunderstood what you were asking. The later-of-30-day or new-year rule comes into play when you want to re-convert previously recharacterized funds. What you actually need to do is to ask your custodian to re-code your contribution to a TIRA (Traditional IRA) contribution in their system and then, as you correctly stated, you can convert to a back-door Roth IRA. This should be handled easily enough by the custodian. Be sure to file form 8606 when you file your 2015 income tax return. Since you’ll probably want to repeat this maneuver annually, I recommend keeping the TIRA account open with a few dollars (less than $10 if the custodian allows) so you will not have to open a new account every year.
This list of state laws for IRA protection that I like to point people to is http://bit.ly/20uxKF0. You’ll find a column for both TIRA and Roths. In general, what you need to watch for is states that limit exemption only to the extent necessary for the support of the debtor and any dependent. California is one of the worst.
I hope this helps!
I couldn’t find a specific example on the IRS.gov site that said whether or not you have to wait to reconvert after doing that. You definitely have to wait if you have done a Roth conversion.
You can leave $0 in your Vanguard traditional IRA for at least a year without them closing the account.
There should be no wait because there is no conversion or recharacterization. All she did was contribute to a Roth IRA. The contribution should have gone to a TIRA instead. She simply needs to have the custodian re-code the contribution, which can be done at any time, preferably before the forms go out in the first quarter of 2016. Linda inadvertently used the term “re-characterize”. That is not what this would be – it wouldn’t even be a transaction. We do this all the time, just have to instruct the custodian to re-code.
By the way (Linda) you do not contribute to a “non-deductible” TIRA. You simply contribute to a TIRA and you will have basis if you are not able to deduct any or all of your contribution due to income limitations. I guess that is one of the terminology misunderstandings I run into a lot. Not irritating, just confusing. This is why filing the 8606 each year is so important. The IRS used to allow taxpayers to catch up for as far back as necessary but now they invoke the SOL (Statute of Limitations) so that, in general, you can go back only 3 years.
Thanks for the clarification.
The 8606 will be cleaner if you can reconvert in 2015 instead of waiting.
You’re welcome. However, Linda would not be “re”converting because there is no conversion (yet). She will convert her TIRA to a Roth via the back door. If she later changes her mind and decides to recharacterize, then she will have the option to reconvert (after the “later of 30-day or EOY window” you described has passed)
Not sure what you mean by a “clean” 8606, so I would benefit from your perspective.
Sorry to keep beating this issue…but the article WAS about proper use of vocabulary.
You’re right. It wouldn’t be a reconversion.
By clean 8606, I mean one where your contribution and conversion happen in the same calendar year.
Although my colleagues are not medical professionals but financial professionals, I cringe at “short-term investing”. In the short term, you are speculating (gambling). True investing is a long-term endeavor undergone for the purpose of growth in value, whether buying real estate or purchasing mutual funds. This is my personal definition, anyway.