Learn all that you need to know about IRA’s so that you can maximize the use of them and Build Wealth more efficiently so that you can do more of what you desire during your retirement years…

 

CAUTION: 30-minute read

 

Nasdaq Historical Returns

The Nasdaq stock market comprises two separate markets, namely the Nasdaq National Market, which trades large, active securities and the Nasdaq Smallcap Market that trades emerging growth companies.

Russell 2000 Historical Returns

The Russell 2000 Index is a stock market index that measures the performance of the 2,000 smaller companies included in the Russell 3000 Index. The Russell 2000 is managed by London’s FTSE Russell Group, widely regarded as a bellwether of the U.S. economy because of its focus on smaller companies in the U.S. market.

S & P 500 Historical Returns

The S&P 500 Index is a basket of 500 of the largest companies of both the New York Stock Exchange (NYSE) and the NASDAQ.  The Standard and Poor’s 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States.

Dow Jones Historical Returns

The Dow Jones Industrial Average (DJIA) is a stock market index that tracks 30 large, publicly-owned blue-chip companies trading on the New York Stock Exchange (NYSE) and Nasdaq. The Dow Jones is named after Charles Dow, who created the index in 1896 along with his business partner, Edward Jones. Also referred to as the Dow 30, the index is considered to be a gauge of the broader U.S. economy.

New York Stock Exchange

The New York Stock Exchange (NYSE) is a New York City-based public marketplace for trading stock. It is the largest stock exchange in the world based on market capitalization of its listed securities and dates back to 1792.

 

MarketWatch–Learn what is happening in the markets today…

 

IRAs are an important tool for building wealth for those who are employed and particularly those who lack an employer sponsored plan where they work.  Just what are the rules and guidelines as it relates to IRA’s, and how can you use them to maximize your retirement accounts if you now qualify for the utilization of them as you build your retirement nest egg?

 

It is important that you unmask and learn all that you can about IRAs and how you can use them for creating wealth for you and your loved ones in all ways possible, proactively when possible.  Improving your wealth in ways that could be of significant benefit to you and your family can be made easier if you unmask or learn all that you can about IRAs proactively as opposed to after the fact (after your earned income years come to an end).

 

You want to ensure that you look at IRAs and determine if they can be of value to you as you build wealth and not allow blind spots to cause you to miss out on important facets of IRA utilization that you could possibly miss out on and make your retirement years less enjoyable!

 

Over the years TheWealthIncreaser.com has discussed many financial matters with consumers. No topic seems to be as misunderstood or improperly grasped by consumers on a consistent basis than that of the topic of IRAs.

 

It is important that you simplify your understanding of IRA’s—and particularly as it relates to taxation—so that you can make an informed and well thought out decision—if you are considering IRAs in your financial portfolio for retirement or other purposes.

 

IRA Basics

With a traditional IRA—you get a tax benefit up front in the form of a tax deduction on your personal tax return.

 

You would pay taxes on your distributions at “ordinary income” tax rates upon withdrawal and if done before age 59.5 and no exception applied–a 10% early withdrawal penalty would also apply.  With a ROTH IRA you get no tax deduction up front, however “all contributions” and “qualified” distributions are tax free.

 

Qualified distributions are distributions after age 59.5 or those that are made due to an exception or other guidelines that are outlined in the tax code.

 

If you own—or anticipate owning a Traditional IRA or a ROTH IRA, and you make a “non-qualified” distribution, you may have to pay federal income taxes on withdrawals—and in some cases be socked with a 10% penalty on top of the income tax bill.

 

In this discussion TheWealthIncreaser.com will look at a number of ways that you can utilize a ROTH IRA or a Traditional IRA to build wealth more effectively.

 

The goal of this discussion is to keep conciseness–and to the point actions at the center, however conciseness and to the point on IRAs can be difficult.  Key points will be reiterated (repeated) in an attempt to enhance your understanding.

 

Broad Stock Market History Charts

 

Nasdaq

Dow Jones Industrial

S & P 500

Russell 2000

 

Key Points that you need to know about IRA’s 

 

Important questions that you need to ask yourself include:

 

*Do I even qualify

 

You qualify if you have “earned income” and that income doesn’t exceed certain thresholds that are established by law.  The amount of the contribution limit and the thresholds are adjusted upward annually, generally speaking.

 

You can fund an IRA if you have a 401 (k) plan or other retirement plan through your employer. Having a workplace retirement account could make you “ineligible to deduct traditional IRA contributions” on your taxes annually.  Funding a 401 (k) could help you reduce your taxable income so that you can directly fund a Roth IRA.  Many employers also offer an employee match with 401k plans so you want to give the match option considerable attention.

 

Single Limits

 

A Traditional Spousal IRA allows the working spouse to make tax-deductible contributions on behalf of the non-working spouse, and the contributions grow tax-deferred, which means taxes are paid only upon withdrawal.

 

A spousal IRA is a strategy that allows a working spouse to contribute to an individual retirement account (IRA) in the name of a non-working spouse with no income or very little income. This is an exception to the provision that an individual must have earned income to contribute to an IRA.

 

If you are not covered by a plan you (and possibly your spouse) can contribute up to the contribution limit for that year.  If you are married and you or your spouse have a plan at work, your contribution deduction would be limited if your income was greater than $220,000 to $240,000 for tax year 2024 and would phase out all together at income over $240,000.

 

Keep in mind you can still contribute up to the annual limit, however you could not deduct the contribution on your tax return.  Additionally, when you are taxed, the “contributions that were not deductible would not be taxable” however, the earnings would be taxed at your ordinary income rate.

$1,000 Monthly Withdrawal Rule for Retirement…

$1,000 Tax-Free Retirement Account Withdrawal Allowance under SECURE ACT 2.0

In 2011 the income cutoffs for a traditional IRA where you can get the full deduction was $56,000 and partial deduction was $65,999 if you were single.

 

In 2024 the income cutoffs for a traditional IRA where you can get the full deduction is $146,000 and partial deduction is $161,000 if you are single.

 

As you can see, over that 13 year period the amount adjusted upward by $90,000!

 

In 2011 the income cutoffs for a ROTH IRA where you can get the full contribution was $107,000 and partial contribution was $122,000 if you were single.

 

In 2024 the income cutoffs for a ROTH IRA where you can get the full contribution is $230,000 and partial contribution is $240,000 if you are single.

 

As you can see, over that 13-year period the amount adjusted upward by $123,000!

 

Married Limits

In 2011 the income cutoffs for a traditional IRA where you can get the full deduction was $90,000 and partial deduction was $109,999 if you are married.

 

In 2024 the income cutoffs for a traditional IRA where you can get the full deduction is $230,000 and partial deduction is $240,000 if you are married.

 

As you can see, over that 13-year period the amount adjusted upward by $140,000 for the Traditional IRA.

 

In 2011 the income cutoffs for a ROTH IRA where you can get the full contribution was $169,000 and partial contribution was $179,000 if you are married.

 

In 2011 the income cutoffs for a ROTH IRA where you can get the full contribution was $230,000 and partial contribution was $240,000 if you are married.

 

As you can see, over that 13-year period the amount adjusted upward by $61,000 for the ROTH!

 

Keep in mind that the above figures represent the “income cutoff” that is based on your AGI or Adjusted Gross Income—not Total Income!

 

Contribution Limits

Single:

 

The annual contribution limit for 2011 was $5,000 if you were single and had earned income ($6,000 if you were over age 50).

 

By contrast:

 

The annual contribution limit for 2024 is $7,000 if you were single and have earned income of at least the contribution limit ($8,000 if you are over age 50).

 

Married:

The annual contribution limit for 2011 was $10,000 if you are married and have earned income ($12,000 if you are both over age 50).

 

The annual contribution limit for 2024 was $14,000 if you are married and have earned income of at least the contribution limit ($16,000 if you are both over age 50).

 

Always remember that if your earned income is “less than” the contribution limit—your contribution is limited—to your earned income!

 

Deadline to Contribute

Also keep in mind that you have until the tax deadline (April 15, 2025) to fund your IRA for 2024 and be sure that you understand that with a traditional IRA—your contributions are in pre-tax dollars (deducted on your tax return if you qualify) and your withdrawals are taxable at your ordinary income tax rate at the time of withdrawal.

 

You want to always know that you can make 2024 contributions up until the April 15th deadline in 2025, and you can make 2025 contributions up until the 2025 tax filing deadline of April 15, 2026. 

 

In future years the tax deadline of April 15th is normally the deadline unless the date falls on a weekend or federal holiday.

 

If you file for an extension, the cutoff date for contributions remains April 15th of the tax year or the next business day if the 15th is on a weekend or holiday!

 

With a ROTH IRA you pay your taxes upfront, however you or those who inherit your IRA—will owe no taxes on withdrawals but would be required to make RMDs.  Depending on your tax bracket—the ROTH is often the best choice in the long run—for many.

 

*Again the 2024 Contribution limits are $7,000, or if you are age 50, $8,000

 

*Know that Income Limits Apply when investing using IRAs as there is a minimum that you must earn to qualify–and a maximum that will eventually phase you out.  With a traditional, you can continue to contribute after the phaseout, however you would not be able to deduct the contribution.

 

Can I convert from a Traditional to a ROTH IRA

You can convert from a Traditional to a ROTH regardless of your income.  Be aware that you might have a large tax bite!

 

You want to plan and strategize the conversion to help minimize your taxes in a very serious way as there can be serious tax consequences if you fail to do so!

 

If you do not yet have an IRA—you can set up one at any time, if you qualify and the process is fairly simple.

 

You can also convert to a ROTH IRA at any time—just be aware of your taxes that you will have to pay—prior to doing the conversion–not AFTER!

 

Converting is particularly important if you anticipate being in a higher tax bracket in your retirement years.  With 2024 tax rates from the TCJA scheduled to end at the end of 2024—you would face a maximum tax rate of 35%.

 

Depending on your age and income streams—it can often be difficult to determine whether you will be in a higher or lower tax bracket during your retirement years, but you want to make the best educated guess possible to assist in your planning at this time.

 

IRAs & College Planning

• Regardless of whether you have a Traditional or Roth IRA, there is a penalty-free way to use your retirement savings to pay for your education, your children’s, or your grandchildren’s education.  IRA withdrawals used for qualified education expenses at an eligible institution are “exempt” from the penalty.

 

• Higher education is expensive, and if loans are taken out to pay for school, it may take 10 to 30 years to repay a student loan when you borrow, depending on the amount and your repayment schedule. While direct higher education expenses qualify for penalty-free withdrawals from a traditional individual retirement account (IRA), the payment of student loans and interest don’t.

  Be aware that early withdrawals from a Traditional IRA—if you’re not yet age 59½—used to pay for student loans are subject to a 10% penalty, plus any deferred income taxes owed.

 

• Early withdrawals from a ROTH IRA, however, may be free from penalties as long contributions—and not gains—are touched before age 59½.

 

• It’s important to determine whether using IRA funds to pay off student loans is viable for your situation as everyone’s financial profile is unique, therefore you want to proactively run the numbers to see if it makes good sense financially as well as you psychologically being comfortable about your decision.

 

ROTH accounts could also work for you in college planning—and as an added bonus if your child has enough to go to college with other means—such as your current income, financial aid, scholarships etcetera—you could avoid using the ROTH (or traditional for that matter) for your child’s education—and continue building up the account for (your and your spouse’s) retirement years.

 

Withdrawals of your “contributions” would be tax free.  There would be no 10% early-withdrawal penalty on “earnings” if you use the money for “educational” expenses.

 

Even with a ROTH, if you were under age 59.5 and you held the account for less than five years. you would owe tax on the “earnings” at your ordinary income tax rate plus a 10% penalty for early withdrawal unless an exception was applicable.

 

Regardless of how you use your contributions, they would be tax free if withdrawn from your ROTH account for any reason!

 

Traditional IRA & Home Purchase

You can take funds out penalty free to purchase your home whether you have a ROTH and/or Traditional IRA.

 

You can also invest in Self-Directed IRAs and Invest in Real Estate.

 

ROTH IRA & Home Purchase

You can take funds out penalty free to purchase your home whether you have a ROTH and/or Traditional IRA.

 

You can also invest in Self-Directed IRAs and Invest in Real Estate.

 

If you plan on using a traditional or ROTH for your home purchase–or investing for retirement using real estate investing, make sure you have a well thought out strategy.

 

Be sure you have your retirement goals in place and a strategy to get to the “number” that you need to reach—dollar wise—to live at your pre-retirement levels at a minimum–where possible.

 

For example, if your “number” was $500,000 and you were age 65, you would be able to withdraw $20,000 per year for approximately 30 years assuming a modest rate of return.

 

You would also need to factor in your Social Security and any other income that you would receive monthly.

 

If tapping into your ROTH for your child’s educational expenses would prevent you from getting to your “number”—you would have to increase the ROTH contributions—or other Retirement Account contributions—or pursue another educational and/or retirement funding strategy for you or your loved one.

 

If you plan on using a Traditional or ROTH account for educational funding be sure to start well in advance.  ROTH accounts have a dollar contribution per year limit—and a little higher if you are over age 50.

 

Traditional IRAs allow you to contribute regardless of your income, and what you can “deduct annually” is limited!

 

If you are married your spouse can also contribute up to the annual amount limits, or a little higher per year if age 50 or older if qualifications are met.

 

Always Remember—in order to Contribute to “Any” IRA You Must Have “Earned” Income!

 

Keep in mind that in order to contribute to a ROTH you must have earned income (employer or self-employed) and there are income limits of Modified Adjusted Gross Income for Single and for Married Filing Jointly that are adjusted annually.

 

An example of what you can achieve using IRA contributions:

 

If you contribute just $5,000 annually from the time your child is born, you would have $90,000 in “contributions” alone.  Assuming you had a modest annual return, your total account value could be over $200,000 by the time your child attended college.

 

If your spouse also contributed the total “contributions” would be over $180,000 and the account value could be over $400,000 by the time your child attended college.

 

IRA Investment Choices

Stocks, Bonds, Mutual Funds, CDs, real estate, precious metals, blockchains and many other financial accounts can be a part of your IRA if set up and structured properly.

 

IRA’s & Alternative Investments

If you open a self-directed IRA with a custodian willing to deal with alternative assets—you could invest in real estate, gold bullion, tax liens, racehorses and other more speculative and/or exotic investments.

 

However, you cannot invest in art or life insurance with your IRA account(s)!

 

It is not always wise to invest in more speculative IRA holdings—even though you are legally allowed to do so.  When dealing with IRA’s that offer more exotic types of investments—you can often run into those who are con-artists and very smooth in their articulation of what they are offering—and the returns you could possibly get may be unrealistic.  You want to have a real understanding of what you invest in and choose your account custodians in a wise and prudent manner.

 

Due to the large number of baby-boomers converting their 401k’s and other retirement accounts to an IRA—con artists and other unscrupulous players feel they have a ripe and lucrative market that they can tap into for years.

 

You must be very careful if you are even considering any out-of-the-ordinary type of investments.

 

Also, realize that there are even more inherent risks when investing in non-traditional ways.

 

You will have market risk if you invest in gold or real estate.  You must also use funds that are inside of the IRA—for renovations and upgrades that you want to do to real estate you own inside of an IRA!  You will have the risk of horses getting sick or dying—if you invest in racehorses…and so on.

 

If you are determined to invest in alternative—out-of-the-ordinary type of investments—a better option may be to consider doing so (inside of an IRA) with a mutual fund that invests in a broad range of investments and has a five-to-10-year track record of success.

 

If your goal is to invest in real estate—consider a mutual fund (REITs) that invests in a broad range of properties!

 

By doing so you will reduce your risk from being conned by fraudsters—and reduce other risks that were mentioned above.

 

Understanding the IRA rules and guidelines before and after you transition

Traditional IRAs will face taxation upon transfer to beneficiaries and will be taxed at transfer–based on life expectancy of beneficiary.  A ROTH can be transferred tax free with no minimum withdrawals required annually to your spouse, other beneficiaries will face mandatory withdrawals.

 

Traditional IRA

With a traditional IRA, you would set it up with an IRA custodian and contribute to it in the manner that you chose to do so—for example weekly, monthly or yearly.  You have up until the tax deadline of the current year to make contributions for the previous year.

 

Let’s say you contribute $5,000 by the April 15th, 2025, filing deadline.  If you filed your return on April 17th, 2025, you could deduct it on your 2024 tax return on form 1040.  If you were in the 35% tax bracket you could save roughly $1,750 on your taxes if you were able to utilize the full deduction.

 

If you had already filed your return before April 15th, 2025, you could amend your 2024 return—or you could decide to make the $5,000 contribution after April 15th, 2025–and deduct the 2025 contribution on your 2025 income tax return.

 

The correct choice for you would depend on your expected contributions or goals.  To maximize your contributions—you would choose the first option.

 

Taxation at Withdrawal

 

Traditional IRA

If you were to withdraw funds prior to age 59 ½ you would have a 10% early withdrawal penalty and the withdrawal would be taxed at your ordinary income tax rate.

 

If you were to withdraw funds after age 59 ½ you would “not” have a 10% early withdrawal penalty and the withdrawal would be taxed at your ordinary income tax rate.

 

Keep in mind that withdrawals were once mandatory at age 70 ½ now the age is 73 with a Traditional IRA.

 

Roth IRA

With a ROTH IRA “you would pay your taxes on your contributions up front” and then contribute to your IRA.

 

Your earnings would grow tax free and your “contributions” that you later decide to withdraw would be tax free—because you have already paid taxes on them!

 

You cannot deduct your contributions on your personal income tax return!

 

Once you reach age 59 ½ and have contributed for at least five years, you can receive your earnings—or investment gains tax free.

 

Withdrawals are not mandatory at age 70 ½, 73 or any age–BUT WITHDRAWALS WOULD BE MANDATORY TO BENEFICIARIES AFTER YOUR TRANSITION.  IF YOUR WIFE WAS THE BENEFICIARY–WITHDRAWALS WOULD NOT BE MANDATORY.

 

Deadline to Contribute to Traditional & ROTH IRAs

Also keep in mind that you have until the tax deadline (April 15 generally) to fund your IRA annually—and be sure that you understand that with a traditional IRA, your contributions are in pre-tax dollars (deducted on your tax return if you qualify)—and your withdrawals are taxable (normally after you retire).

 

With a ROTH IRA, you pay your taxes upfront, however you or those who inherit your IRA—will owe no taxes on withdrawals.  Depending on your tax bracket a ROTH IRA is often the best choice in the long run for many.

 

If you’re 59.5 or older and have had at least one Roth IRA that has been open for more than five years, withdrawals from any of your Roth IRAs are called “qualified” withdrawals.

 

Your qualified withdrawals would be free of any federal income tax or penalty.  The “five-year period” for qualified withdrawals starts on January 1 of the first tax year for which you make a Roth contribution.

 

If you established your first Roth IRA on April 15, 2021—and the contribution was for the 2021 tax year, your five-year period would start on Jan. 1, 2020.

 

You could begin taking qualified withdrawals at any time after Jan. 1, 2025.  You could also take tax-free qualified withdrawals from any and all Roth IRAs that you own by then—as long as you’re 59 ½ or older.

 

Let’s say you opened a second Roth IRA account in 2021 by converting a Traditional IRA, you could take tax-free qualified withdrawals from that account too—after Jan. 1, 2025—as long as you’re at least age 59 1/2.

 

What Happens if You Take Withdrawals Before Age 59 ½?

If you take a ROTH distribution before age 59 ½, it would be considered a “non-qualified” withdrawal—unless an exception applies.

 

A non-qualified withdrawal or distribution may be subject to federal income tax and a 10% penalty tax!

 

As far as the IRS is concerned, non-qualified withdrawals come first from your annual Roth “contributions”—not your “investment gains or earnings.”

 

If you take out contributions only–you “would not pay taxes on the contributions” as you have already paid taxes on that portion of your ROTH IRA!

 

Always remember that withdrawals from your “contributions” are always tax-free and penalty-free with a ROTH IRA.

 

To figure out how much of your account is “qualified” you would add up your annual contributions to all Roth IRAs set up in your name (do not use any accounts in your spouse’s name).

 

To prove you don’t owe any income tax or penalty, you’ll have to fill out Part III of IRS Form 8606 (Nondeductible IRAs) and file it with your Form 1040 during the tax filing season.

 

If you converted from a Traditional IRA to a ROTH IRA—non-qualified withdrawals are deemed to come from ROTH conversion contributions “after” you determine what your contributions are.

 

To figure out how much is non-qualified due to conversion—you would add up all conversion contributions from converting a traditional IRA or a retirement plan payout to all Roth IRAs set up in your name (again—do not use any accounts in your spouse’s name).

 

Withdrawals from the conversion are federal-income-tax-free, but you could still get hit with a 10% penalty—unless an exception applies.

 

Keep in mind that age 59.5 is generally the required age for starting to receive IRA distributions without getting hit with the federal 10% premature withdrawal penalty tax.  With a Traditional IRA (whether you continue to work or not), there are some circumstances under which you can receive your IRA funds even earlier without the penalty.

 

The 10% penalty applies unless you qualify for an exception:

Exceptions for Early Distributions from an IRA or a Traditional & ROTH IRA include:

• You had a “direct rollover” to your new retirement account

• You received a lump-sum payment but rolled over the money to a qualified retirement account within 60 days

• You were permanently or totally disabled

• You were unemployed and paid for health insurance premiums

• You paid for college expenses for yourself or a dependent

• You bought a house (can be for children or grandchildren—dollar limits apply)

• You paid for medical expenses exceeding 7.5% of your adjusted gross income

• The IRS levied your retirement account to pay off tax debts.

• It has been more than five years since the conversion contribution (the five-year period starts on Jan. 1 of the year when the conversion contribution occurred)

 

Lesser-Known Exceptions:

• Annuitize Your IRA—one way to take money from your traditional IRA without incurring the 10% penalty is to “annuitize” your account.  The way this works is that for five years, or until you turn age 59 1/2 (whichever is longer), you take annual cash withdrawals based on your life expectancy, as predicted by the IRS.

• Withdraw Roth Contributions—the Roth IRA allows penalty and tax-free withdrawals of “contributions” for any reason.  However, once you’ve taken out that money, you don’t have the option of replacing it.

• Take a 60-Day Loan—you can withdraw funds from your IRA for up to 60 days tax-and penalty-free as long as you return the funds to an IRA by the end of the 60-day period.  The IRS looks at this as a non-taxable rollover.

Just make sure that the funds are back in an IRA within the 60 days, otherwise it will be treated as a withdrawal that is subject to taxes and penalties if you are under age 59 1/2!

Also, if you follow this strategy, you can only do it once within a 12-month period for the account in question.

 

Special Penalty-Free Withdrawal Situations:

• First-time home purchase—up to $10,000 for you, your spouse, your children or even your grandchildren.

• Qualified education expenses—for you, your spouse, your children or even your grandchildren. Approved expenses include post-secondary education, tuition, books, supplies and, if the student is enrolled at least half-time, room and board.

• Disability—to qualify for a disability exemption, you must prove that you are incapable of working.

• Un-reimbursed medical expenses—expenses must exceed 7.5% of your adjusted gross income.

• Health insurance for the unemployed—only after 12 consecutive weeks of collecting unemployment benefits.

 

Use caution before you dip into an IRA or any Retirement Account:

Before you start dipping into your retirement stash, you may want to explore other options including a standard bank loan.

 

If you must withdraw funds from an IRA, avoid paying taxes by withdrawing “contributions” from your Roth IRA first.

 

Be sure to tap a tax-deductible IRA last.  Above all, you generally want to use these tax-sheltered accounts as a last resort–unless you have planned upfront to use them–possibly where an exception applies.  And before you raid your retirement savings, make sure you are leaving enough to support your actual retirement–as you want to know your “retirement number” upfront.

 

Key Points to Remember:

• ROTH IRAs have a five-year rule that applies in three situations:

 

• 1) if you withdraw account earnings,

 

• 2) if you convert a traditional IRA to a Roth,

 

• 3) or if a beneficiary inherits a Roth IRA.

 

• Traditional IRA withdrawals used for higher education are 10% penalty free but taxable at your ordinary income rate

• Funds in a ROTH that are withdrawn for higher education would be taxed on earnings only—not original contributions

• Funds in a ROTH that have been there for five or more years would be taxed on earnings only—not original contributions

• Funds in a ROTH that have been there for less than five years would be taxed on earnings only—not original contributions

At this time there is a $10,000 maximum withdrawal of IRA funds for a home purchase—whether Traditional or Roth!

• Traditional IRA withdrawals used for disability or death are 10% penalty free but taxable at your ordinary income rate

• A Roth IRA used for death or disability held in account for less than five years would have no penalty but would be taxed on earnings—not original contributions

• A Roth IRA used for death or disability held in account for more than five years would have no penalty –and would have no taxes

• If you meet the income guidelines and otherwise qualify–you could receive a savers credit (line 4 schedule 3) on top of your traditional IRA deduction

There are no required distributions for a Roth IRA while the original account holder is alive. However, after the account owner dies, their beneficiaries must empty the account according to the rules at the time of death: five years if the account owner died before 2020, and 10 years if he or she died after 2020. An inheriting spouse also has the option of taking RMDs based on their own life expectancy.

 

However, death of a ROTH account owner doesn’t totally get you (the beneficiary) off the hook with regard to the five-year rule.  If you, as a beneficiary, take a distribution from an inherited Roth IRA that wasn’t held for five tax years, then the earnings will be subject to tax.

 

Withdrawals when an exception does not apply:

• Traditional IRA withdrawals would have a 10% penalty UNLESS YOU ARE AGE 59.5 OR OLDER—and would be taxable at your ordinary income rate

• Funds in a Roth IRA for less than 5 years would have a 10% penalty on earnings—not contributions—and would be taxed on earnings at ordinary income rates—original contributions would be non-taxable

• Funds in a Roth IRA for more than 5 years would have a 10% penalty on earnings—unless you are age 59 ½ or older—and would be taxed on earnings at ordinary income rates—unless you are age 59 ½ or older—original contributions would be non-taxable regardless of age

• Finally, any further non-qualified withdrawals from Roth accounts set up in your name (after you’ve tapped all your contributions) are deemed to come from earnings or investment gains.

• Non-qualified withdrawals from earnings are 100% taxable prior to age 59.5 and meeting the the 5 year rule.  You or your tax professional would fill out Part III of Form 8606 to calculate the taxable amount from this layer, and enter that on Form 1040.

• In addition, the 10% penalty applies, unless you’re eligible for an “exception.” If you owe the penalty tax, fill out Form 5329 and enter the penalty on line 8 of Form 1040.

 

What if I am age 59 ½ but I fail to meet the five-year test:

Any Roth IRA withdrawal taken before passing the five-year mark would be considered a non-qualified withdrawal.  As such, it may be subject to income tax and a 10% penalty tax.

 

In this case, non-qualified withdrawals are generally handled in the same order as above:

1)—first from annual contributions

2)—then from conversion contributions

3)—and lastly from investment gains or earnings.

 

Most importantly you want to know that, non-qualified withdrawals from investment gains are subject to income tax, and, if you’re under 59.5, the 10% penalty (unless you’re eligible for an exception) would apply.

 

You or your tax professional would fill out Part III of Form 8606 to calculate the taxable amount from investment gains and enter that figure on Form 1040.  If you owe the penalty tax, fill out Form 5329 and enter the penalty on line 8 of Form 1040.

 

If you qualify for the home purchase exception: If you’ve passed the five-year test but you’re under 59.5, a special exception allows tax-free and penalty-free Roth withdrawals in order to buy a principal residence.

 

However, there’s a lifetime $10,000 limit on this deal, and you must use the money within 120 days of the withdrawal.  The home buyer can be you or certain relatives (including children and grandchildren).  However, the buyer must not have owned a principal residence within the two-year period ending on the purchase date.

 

Final Thoughts on Taxation & IRA’s

While the tax rules for “Traditional” and “ROTH” contributions and withdrawals may seem complicated, your custodian (or your tax professional) will clear up much of your confusion by completing Part III of Form 8606 after you receive tax documents from your custodian.

 

In addition, you will receive a form 1099-R from your IRA custodian or trustee shortly after the end of any year in which you take withdrawals.

 

By providing this form to your tax professional—or utilizing the form yourself if you do your own taxes–you can complete your taxes in an efficient manner.

 

As for contributions—you mainly have to keep the income cutoffs in mind if you have income that is in the income cutoff limitation ranges.  Your contribution limit is easy to remember—as it will be $7,000—or $8,000 as of 2024 if you are age 50 or older, and the number could change slightly from year to year.

 

The 1099-R would show the total amount of withdrawals for the preceding year and your tax with-holdings (and the IRS gets a copy) so if you took any “non-qualified withdrawals”—the IRS will expect to see a Form 8606 included with your return.

 

With a traditional IRA—you get a deduction up front on your tax return if you qualify, and you pay taxes on your distributions at “ordinary income” tax rates in later years after you retire (or before if you took a early distribution and there would be an additional 10% early withdrawal penalty)—whereas, with a ROTH you get no deduction up front, however all “qualified” distributions are tax free if you meet the 5 year rule and age 59.5.

 

Be sure to go to our individual retirement account page where you can find other helpful ways in which you can use IRA’s to reach your and your family’s retirement and other goals.

 

For income tax preparation you can utilize the tax professional of your choice—or if your tax situation is not very complicated you can choose to do your taxes yourself!

 

Many retirees who reach age 70 ½ were required to begin to make withdrawals from their retirement accounts in accordance with the IRS guidelines.  In 2023 the age was moved up to 73–giving you more time for your traditional IRA account to grow, if you have no need for the funds prior to age 73.

 

As for your annual taxes once you start receiving your traditional IRA distributions, those who are not working would normally pay their taxes (estimated taxes) in April—June—September and the following January on a continuous cycle until their transition or the funds in the account ran out.   For those who continue to work after age 73, they may be able to avoid paying estimated taxes by withholding their taxes at the appropriate level on their W-2.  Still others who are not working could comply with their withholding requirement by having taxes withheld on their social security income or W2P.

 

To avoid the IRS penalty for “underpayment of taxes” you have the option of paying 100% of your previous year taxes through estimated payments (previous year tax divided by 4) in April—June—September and the following January or you can pay 90% of your current year taxes. 

 

You can also choose to have your taxes “voluntarily” withheld by adjusting your W-4P for your pension income that goes on your 1099R that you would get during the tax season.

 

Even your social security benefits can be “voluntarily” withheld by you electing to have taxes withheld (use form W-4V) at varying percentages such as 7%, 10%, 15% or 25% of your monthly benefits.

 

If you receive income from your Traditional IRA, you have more flexibility.  You can choose to have no withholding, otherwise 10% will be withheld by law.  At the other end of the spectrum, you could tell your IRA custodian to withhold 100%.

 

IRA distributions are considered made evenly, regardless of when you receive them during the year.

 

You could choose to receive your IRA distributions yearly if you are able to live off of your other income sources—say November or December and have an amount withheld that could cover the taxes that you owe from all of your other taxable income (must be over age 70 ½–now age 73).

 

To effectively use this strategy (avoid the underpayment of taxes penalty) your RMD or required minimum distribution must be large enough to cover your taxes that would be owed.

 

You would avoid having with-holdings on your other income, avoid writing a check for estimated taxes every 3 months or so–and make your life less stressful by doing so.

 

Conclusion

The strategy that you use with your IRA account(s) will affect not only you, but potentially your heirs as well.

 

It is important that you give serious attention to how you will receive your retirement income after you turn age 70 ½–now age 73 as of 2023, and you have the opportunity to structure your income in a way that can minimize your tax bite or make the payment of your taxes more convenient.

 

 Non-spouse Beneficiaries

Also give serious consideration of what will happen to your retirement income after you transition. 

 

If you are married the process is simpler, however if you have non-spouse heirs in the picture you don’t want to trigger a large tax bill for them by not knowing what may occur after you transition.

 

Non-spouse beneficiaries of “any age” who want to stretch the IRA over their own “life expectancy” must start the RMDs the year following the year the owner of the IRA transitioned.

 

Non-spouse heirs will have to pay tax on distributions of deductible contributions and earnings from a traditional IRA!

 

Even though non-spouse ROTH IRA owners will not feel a tax bite, they still must begin taking RMDs.  If they fail to do so a 50% penalty could apply on the amount that should have been withheld for the year.

 

If you miss the RMD for the year in question, you can still possibly avoid the penalty by emptying the account within 5 years of the owner’s death.

 

However, death doesn’t totally get you off the hook with regard to the five-year rule.  If you, as a beneficiary, take a distribution from an inherited Roth IRA that wasn’t held for five tax years, then the earnings will be subject to tax.

 

The size of your ROTH IRA and the age of your intended beneficiary will come into play and you must plan accordingly at this time to help minimize or eliminate the penalty for your intended beneficiary(s).

 

Also realize that non-spouse beneficiaries cannot roll an inherited IRA over into their own IRA!

 

If you are a spouse, and you inherit an IRA you must take RMDs based on your life expectancy.

 

A separate account must be set up with a title that includes the deceased name and the fact that the account is for a beneficiary(s).   Also have the non-spouse heir name successor beneficiaries on the newly titled account(s).

 

If a number of non-spouse heirs are involved, it is important that they “split the IRA” so that the money can continue to grow tax deferred, otherwise the age of the oldest beneficiary will be used to calculate RMDs which would shorten the growth period of the IRA.

 

To be valid the split must occur by December 31^st of the year following the IRA owner’s transition!

 

If you decide to leave your IRA with a charity or multiple non-spouse beneficiaries including a charity or other non-person entity that entity must receive their share by September 30^th following the year of the owner’s transition.

 

If that share isn’t paid out, you will create a problem if a non-spouse beneficiary(s) is involved.

 

The entity must be paid out and the account must be split (mentioned above) otherwise your beneficiaries have to empty the account within 5 years if the owner transitioned before his or her required beginning date for taking distributions.

 

If the owner died after their RMD date the beneficiary(s) must take annual RMDs based on the deceased life expectancy, as noted in IRS tables.

 

If a trust is involved the process works a little differently as the IRA custodian must receive a copy of the trust by October 31^st of the year following the year the owner transitioned.

 

If the IRA custodian does not receive a copy of the trust in a timely manner the trust will be considered a non-designated beneficiary and the payout rules mentioned above would apply to the trust.

 

Although a lot about RMDs has been discussed, it is important that you process and apply what may be relevant or potentially relevant to you and your family at this time.

 

Be sure to discuss required minimum distributions and tax strategy and plan with your family and other professionals in ways that you can have favorable outcomes.

 

By doing so you can lessen your taxes, make your heirs life less stressful, build your wealth more efficiently and transfer your wealth after you transition in a manner that is best for all parties involved.

 

 

 

IRA’s play a critical role in the United States for workers who lack a retirement account that is sponsored by their employer and is a major tool for those who are in the know and are willing to use the power of compounding and investing consistently over time for their benefit.

 

Whether a Traditional or a ROTH, IRA’s can play an important role for those who qualify and help them live out their retirement years with more dignity.  By starting early and combining the returns with retirement accounts, other investments and social security income, it could provide the needed edge that allows better living for you and your spouse in your retirement years.

 

The bottom line is that IRAs—both ROTH and Traditional are an important tool to help you reach your retirement and other goals and should be given strong consideration by you if your goal is to improve your living conditions for yourself and your family to a high level in possibly a more “tax efficient” manner.

 

With a traditional IRA—you get a deduction up front on your tax return, and you pay taxes on your distributions at “ordinary income” tax rates—whereas, with a ROTH you get no deduction up front, however all “qualified” distributions are tax free.

 

A Properly Funded IRA Can Enhance Your Future Living Conditions

 

If you have addressed your finances in a comprehensive manner and are in financial position to do so—IRAs should be a part of your financial strategy to help you and your family attain the future goals that you desire.

 

Be sure you use realistic projections and you invest consistently using a portfolio that fits your investment style. You can also consider target-date funds inside of an IRA.

 

By starting early in your “life stage” you can set yourself and your family up for real success—in a relatively painless manner.

 

You must not only be good or excellent in the management and understanding of your IRA, but you must also be able to tell someone else about IRAs.  It is your connection and your presentation to others that is at stake and is critical for your successful spreading of how to use IRAs and other wealth building techniques to not only reach your highest heights, but help others reach theirs as well.

 

Isn’t it time to get your IRA and other Retirement Planning under way–today?

 

All the best to your IRA success…

 

Note: This discussion is not intended to be financial or legal advice and the accuracy of all information cannot be guaranteed.  Even though all reasonable action was taken to ensure accuracy, accuracy cannot be guaranteed.

 

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