02 Mar I’m disabled. Can I do a Roth IRA? Should I do a rollover?

Q. I have been retired from the workforce, disabled, for 10 years. I still have some money in my thrift savings plan but I haven’t been able to contribute while I’ve been disabled. Can I do a Roth IRA? Should I take the funds from my plan and invest them elsewhere?
— Retired and disabled

A. Before you take funds from your thrift savings plan, let’s talk big picture.

You need to think about your overall financial goals before you make any moves with your investments.

The cornerstone of a sound investment plan is an overall asset allocation that dictates what percentage of your funds will be invested in various types of asset classes, such as domestic and international stocks, bonds, and alternative investments, said Charles Pawlik, a certified financial planner and chartered financial analyst with Beacon Trust in Morristown.

He said some of the factors that go into determining what the appropriate asset allocation or mix of investments may be for you include but are not limited to the average annual rate of return you may need to earn on your investments in order to meet your needs over the long-term, your willingness and ability to tolerate volatility/risk and your time horizon.

These and other factors should ideally be looked at in concert with a broader financial plan that considers your overall assets, income, and expenses/cash flow needs to determine what the appropriate mix of investments may be, Pawlik said.

In terms of what accounts you may be able to use to invest going forward, you would need to have earned income in order to make future contributions to either a Roth IRA or a Traditional IRA to build on your investable assets, Pawlik said.

If there is sufficient earned income to make the contribution, the maximum contribution that can be made to a Roth or traditional IRA for 2020 is $6,000, with the ability to make an additional “catch-up” contribution of $1,000 ($7,000 total) if you are age 50 or older. There is no longer an age restriction in terms of making contributions to a Traditional IRA, as the age restriction was repealed with the recent passage of the SECURE Act, he said.

“Contributions are made to a traditional IRA on a pre-tax basis and subsequent withdrawals are taxed as ordinary income, whereas contributions made to a Roth IRA are made on an after-tax basis with subsequent withdrawals from the account being tax free,” he said.

Determining whether or not a Roth IRA or traditional IRA would be most advantageous for you has to do with your overall goals, income, and tax situation.

“If you are not eligible to make contributions to a Roth or traditional IRA because you don’t have earned income, you have the option of establishing a brokerage/investment account to invest excess funds,” Pawlik said. “A brokerage account is not a tax-deferred account like a 401(k) or IRA in that you will pay taxes on income earned within the account, as well as on capital gains that are realized in the account.”

But capital gains generated on the sale of investments that have been held for at least one year will be taxed at preferential capital gains tax rates versus ordinary income tax rates, he said.

Assuming that you contributed to your thrift savings plan on a pre-tax basis, you would not be able to roll these funds over to a Roth IRA, which is contributed to on an after-tax basis without paying ordinary income tax on the funds you transfer to a Roth IRA, Pawlik said.

“You would have the ability to roll over the funds in your thrift savings plan to a pre-tax rollover IRA account in a non-taxable transaction,” he said. “One of the primary benefits of doing so would be the ability to invest in the range of investments available to investors today including mutual funds, exchange-traded funds as well as individual stocks and bonds.”

That’s a contrast to your thrift savings plan, which will limit the lineup of mutual fund investments you can select.

Keep in mind if you want to convert any pre-tax funds to a Roth, you’d have to pay taxes on the amount converted, and it’s best to do that with funds outside of the amount rolled over.

Pawlik said if you made after-tax Roth contributions to the thrift savings plan, those funds should be rolled over to a Roth IRA. It is important to ensure that you designate beneficiaries for your IRA account if you go the route of rolling your funds from your plan over to an IRA, he said.

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This story was originally published on March 2, 2020.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.