DD is doing one month externship this winter. Her employer offers 401k after 10th day of employment so technically she can participate. Does it make sense to put 5k into 401k so she will not be required to withdraw upon leaving? She doesn’t know if employer has a matching plan, but 5k seems like a big chunk of money. Putting less doesn’t make sense since she needs to have at least that much in the account for employer to keep managing it after her internship ends. Thoughts?
After leaving employment, she can direct rollover the 401k money to a rollover IRA, whether or not the former employer wants her to.
So if she wants to save for retirement in a tax privileged account, she may want to investigate investment options that she can open an IRA account for (mutual fund companies and brokerage firms offer IRA accounts) and have it ready to receive the direct rollover when she finishes employment.
How much will she be earning in that month? Over $5000?.
What is the tax implication of the rollover to IRA? I know that her direct contributions to IRA would not be tax deductible, but to 401 would be.
Yes, she gets generous compensation and no significant expenses that month so technically she can do it, the question is if she should contribute that much to retirement plan in her late teens.
https://www.irs.gov/retirement-plans/plan-participant-employee/rollovers-of-retirement-plan-and-ira-distributions describes rollovers. Note the need to do a direct rollover to avoid withholding.
It doesn’t make much sense to contribute pre-tax income if she is in the lowest tax bracket or paying no tax at all. Why not just fund a Roth IRA if there is no match from the employer? That’s what I encouraged my kids to do, because the contributions are accessible later on (after 5 years) but will not be counted as assets if they are seeking financial aid in the future (thinking of grad school).
If there is a company match then see if they offer a Roth 401K option. If not then a Roth conversion is possible after rolling the funds to an IRA, but I’m not sure if that will have unpleasant kiddie tax implications if she is still a dependent.
Will she work during 2019 aside from the internship? If so consider the (Roth) 401k and Roth IRA.
Yes she will be interning for about twelve weeks during the summer. I estimate that she will have to pay about 3k combined in federal and state income tax . The company she is going to join in the summer doesn’t offer retirement plans to interns. Why Roth option for 401k is preferable? Because her tax bracket is not too high?
Roth puts in money post tax and then compounds and withdraws tax free. It’s unlikely, as a full time student that she will make enough money to pay much if any taxes, even with a good paying internship over the summer, so a pre-tax contribution that she’ll pay tax on at withdrawal doesn’t make much sense. Also, make sure the fees don’t completely errode what she puts in. Not all company sponsored plans are created equally.
My son had a similar opportunity during an internship and just passed on the company 401k since he wasn’t eligible for matching (you should always opt in if matching is an option). He opened an Vanguard Roth IRA instead and manages it on his own.
In terms of Roth versus traditional IRA or 401k, Roth pays taxes at the front door (i.e. after-tax money goes in, no tax upon withdrawal), while traditional pays taxes at the back door (i.e. pre-tax money goes in, withdrawal is taxable). Both avoid paying yearly taxes on realized gains. If tax rates are equal at both ends, then the result is the same (assuming same investments). However, if tax rate is lower now than later, Roth is preferable; if tax rate is higher now than later, traditional is preferable. Of course, tax rates at retirement withdrawal cannot be predicted easily, especially for someone decades away.
Exactly, a ROTH is the superior choice in your situation. That is what I am having my D do this year.
Not sure what the rules are if she does a rollover from Roth 401k to IRA, but the other advantage of a Roth over a traditional IRA is that she can withdraw her contributions (but not interest) without penalty at any time. Retirement funds are also not considered when schools determine financial aid awards.
We checked with my BIL who is an accountant — D2 earned $4500 (approximately) in summer and another $2K during the semester. She put $4K into a Roth 403b and was also allowed to fully fund a Roth IRA based on her $6500 of earned income for the year.
Thank you everyone! A lot of good information here, I sort of overlooked the fact that since she only works three and a half month out of the year even with a very generous compensation the tax savings of a regular 401k is not that big. Also it is a very good point about watching for account fees. This particular employer offers plan with Vanguard so it probably as good as it can get.
@CIEE83 and @Ballerina016 - This student can roll from a Roth401k to RothIRA without any problems. Chances are that Vanguard has a nearly seamless way to do just that when the time comes.
My son did an internship one summer, but the place he interned counted the money as a stipend, and not earned income (or something like that). He was unhappy because he couldn’t contribute to his ROTH account. I just bring that up in case it may be an issue in this or someone else’s situation.
Does income earned overseas count towards one’s ability to contribute to an IRA (traditional or Roth)?
@happymomof1 - I was referring to the rules about withdrawing your original contributions, if they came from a 401k rollover. That to me is a huge benefit for a young person— they can sock away as much as possible knowing that they can get a lot of it out without penalty if they need to. Sorry I wasn’t clear.
When I was pregnant with S in the late 1980s, I contributed to a deferred comp plan in the year I worked for the state. I only contributed $4500. I later also rolled a very small IRA into it. Today, with no other additional contributions, it’s worth over $100k. 30 years of compounding and a broad index fund with low fees can grow nicely if left alone. Just saying.
We’ve encouraged our S to max out his retirement accounts while he’s young and single. He has significant funds in Roth IRAs, 401ks & 403s, as well as regular savings and investment accounts.
As others have mentioned, most retirement accounts can be rolled into IRAs once the employee leaves employer—generally management fees are lower with IRAs.
DD finally sent me paperwork regarding 401k. Company matches 2% immediately, but one would need 3 years to become vested. Her internship is only one month long. They offer both Roth and regular 401k plans. So she has option of contributing into 401k or just open IRA with Vanguard on her own. Is one scenario more preferable than the other?