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Are you confused by IRA Rules?Submitted by Watters Financial Services, LLC on November 19th, 2019
Are you confused by IRA Rules?
Are you confused by IRA Rules? Join the club!
The variety of choices leads many to bury their heads in the sand. There are Traditional IRAs, Roth IRAs, Nondeductible IRAs and Inherited IRAS and IRA Rollovers as well. This is on top of all the various retirement plans offered by employers.
All IRAs are tax-sheltered retirement-savings accounts that you contribute to and you oversee how to invest it. They all grow on a tax deferred basis. This means that you can move money around within these accounts and face no tax consequences until you pull money out someday.There are restrictions on taking out withdrawals from most IRAs until you are age 59½.
Then what are the differences among these accounts?
All IRA accounts allow you to contribute up to $6,000 for 2019, or $7,000 if age 50 or older. Here are what the differences are:
Traditional IRAs allow a tax deduction on contributions. If you are covered by a retirement plan, tax deductible IRA contributions are affected by income limitations:
IRA Deduction Phase Out Rules:
Single/Head of Household $64,000-74,000
Married filing Jointly $103,000-123,000
Married Filing separately $0-10,000
Spousal IRA/ Non-Active Pension Participant $193,000-203,000
If you are covered by a retirement plan and your income is above these thresholds, you cannot deduct an IRA contribution.
If you are over these thresholds, you may still be able to contribute to a Nondeductible IRA. There is no income limitation on contributing to this type of IRA. You simply do not get a tax deduction for contributing. Why do it then? You still get tax deferred growth on the assets until retirement and you will only be taxed on the gains once you withdraw funds at retirement.
The IRA income limits don’t apply to so-called rollovers. Savers typically can make tax-free transfers of their traditional 401(k) funds into traditional IRAs and of Roth 401(k) funds into Roth IRAs, often when they leave an employer. Some companies accept rollovers of IRA assets into their 401(k) plans.
Roth IRAs are also a way to save after tax funds. They are very similar to a nondeductible IRA EXCEPT, they:
• Do not require you to pay taxes on the tax deferred earnings when you make withdrawals.
• Allow withdrawals of your principal tax free if you follow the Five year rule. The five-year rule for Roth IRA withdrawals of investment earnings requires that you hold your account for at least five years before you can tap those earnings without incurring a penalty. It's important to note this rule applies specifically to investment earnings.
• Allow you to continue to contribute beyond age 70.5
• If you file taxes as a single person, your Modified Adjusted Gross Income (MAGI) must be under $135,000 for tax year 2018 and $137,000 for tax year 2019 to contribute to a Roth IRA, and if you're married and file jointly, your MAGI must be under $199,000 for tax year 2018 and $203,000 for tax year 2019.and Roth 401(k)s, savers put in after-tax dollars and withdrawals can be tax-free—forever. If the saver is converting traditional IRA or 401(k) savings into a Roth IRA, income taxes are due on the conversion. For example, say that a 66-year-old recently retired worker has a large traditional IRA because she transferred her 401(k) savings into it. Her current 18% top federal and state tax rate is lower than when she was working and lower than the top 26% rate she expects when she takes required payouts from the IRA.
In this case, paying a tax to convert a Traditional IRA assets into a Roth IRA could be a good move. Of course it’s hard to predict your future tax rate, so most savers should go for a mix of taxable and tax-free retirement savings.
Inherited IRAs are typically IRAs of a deceased person who has left the money to someone who is not a spouse. They are subject to Required Minimum Distributions for the beneficiaries each year (even if you are younger that 70.5).
IRA Rollovers are usually IRA assets that originally were invested in an employer’s retirement plan and were transferred out to an IRA account tax free upon termination of employment.
As you can see, this is a complicated area of planning. Tread carefully before making decisions here.
Please feel free to reach out to us if you have any questions.