The Roth IRA has become a popular planning tool since it was established by the Taxpayer Relief Act of 1997. Originally envisioned as a way for Americans of more modest means to efficiently transfer wealth to the next generation, the Roth IRA offers a number of potential advantages over a Traditional IRA that are particularly attractive to those that are more affluent. While there are many variables to consider when determining which type of IRA is best suited to an individual’s needs, the removal of income limits on Roth IRA conversions has made this tool available to wealthier individuals that would otherwise not qualify to make a Roth IRA contribution because of income-based restrictions. Continue reading
Ask a financial planner whether to save for retirement using a Traditional IRA or a Roth IRA and you may receive an unsatisfying answer: it depends. While the Roth IRA is a much-loved planning tool, whether it’s the best option for you will depend on several factors, but math is not one of them. Continue reading
While preparing tax returns the past few months, we took note that very few clients are contributing to IRAs (Individual retirement accounts). In fact, only 15% of working Americans contribute to an IRA account annually, according to a 2012 study by Greene IRA.
The most common excuses for not contributing to an IRA are:
- I don’t currently have enough money
- I can’t afford to save money
- I am tight on my budget this year and did not plan for it
- I didn’t know about it
The truth is, it is extremely easy to set up and contribute to an IRA – which is a very effective tool to allow you to save money for retirement. In the coming weeks, we’ll discuss more retirement savings strategies and dive deeper into the topic of IRAs; for today, we’ll give you a quick overview on the difference between Traditional and Roth IRAs.
Traditional vs. Roth IRA
|Who may contribute to an IRA?||If you are under the age 70.5, you can contribute if you (or your spouse, if filing joint return) have taxable compensation||You can contribute at any age if you (or your spouse if filing a joint return) have taxable compensation AND your MAGI (modified adjusted gross income) is below a certain amount|
|Are contributions tax deductable?||Sometimes. You can deduct your contributions if you qualify (if you or your spouse are covered by an employer-sponsored retirement plan, your contributions may not be deductable depending on your MAGI)||Never|
|How much can someone contribute?||The lesser of $5500 (< age 50)/$6500 (> age 50) OR your taxable compensation for the year||The lesser of $5500 (< age 50)/$6500 (> age 50) OR your taxable compensation for the year|
|What is the deadline to contribute?||April 15th. There are no extensions.||April 15th. There are no extensions.|
|When is it required to take minimum distributions?||By April 1st following the year in which you turn age 70.5. See this post for more details.||No required age if you are the original owner.|
|Are there penalties for not taking the required minimum distributions?||Yes, equal to 50% of the amount you should have taken out.||None|
|Are distributions taxable?||Any deductable contributions and earnings that are distributed from your traditional IRA are fully taxable; if you have made non-deductable contributions to your IRA, then only a proportion of the distribution will be taxable.||Distributions are not taxable as long as it’s a qualified distribution (must have owned the account for at least 5 years and be over age 59.5)|
|Are there penalties if you take distributions before you reach age 59.5?||Yes, a 10% federal penalty tax applies on withdrawals of both contributions and earnings unless exceptions apply (ask your tax advisor).||There are no penalties on withdrawals of contributions, however there could be a penalty of 10% federal penalty on withdrawal of earnings unless an exception applies (ask your tax advisor)|
 Taxable compensation is earned income; passive income (i.e. from dividends or capital gains) does not qualify
 Check with your tax advisor as amounts change from year to year
If you’re closer to retirement, there are certain decisions that will be required for you to make as it relates to your employer sponsored retirement plan such as a 401K or 403 B plan. For the most part, these monies have accumulated as tax-deferred in these types of accounts. Tax-deferred accumulation means that when you withdraw the money in retirement:
1. The withdrawn money will count as income
2. The withdrawn money will be subjected to income tax (federal and state)
In order to avoid paying income taxes, you generally have two options:
1. Leave the money in the plan
2. Roll the money over into an individual retirement account (IRA)
In order to determine which option makes the most sense for you, you will need to explore the pros and the cons that accompany each of these choices.
Option 1: Leave your money in a 401K or 403B account
Pros & Cons:
The benefit of leaving the money in the 401k or 403b account is that you aren’t required to do anything until you need to withdraw the funds from the accounts. However, you also will not be able to add any money or deposit additional funds into the accounts once you have retired/are no longer working.
Even if you are retired, a benefit of leaving your money in your employer’s plan is that you can continue to manage your money by the plan administrator just as you did when you were an employee.
In order to determine whether or not to leave your money in the account, you will need to check your options as it relates to your withdrawal options. Some companies will limit both the minimum amount you can withdraw at any given time as well as how frequently you can make withdrawals. It is important to make sure that the regulations around frequency of withdrawals and withdrawal amounts matches your future needs. In other words: you need to read the fine print.
It is also important to ensure that you know when you are required to begin taking distributions from your employer-sponsored retirement plans.
Another important factor to consider is, in the event of death, what plan distribution options are available to your beneficiaries.
Lastly, consider the investment options for your employer-sponsored plan. Typical 401ks and 403b plans have a limited number of investment options to the employee.
Option 2: Rollover your money to an IRA
Pros & Cons:
Typically, rolling over employer-sponsored retirement accounts to an individual retirement account will provide you with the greatest amount of control and flexibility. It will enable you to access your money at any point, as frequently as you wish.
Most financial institutions will provide a plethora of options from which IRA holders may choose. In contrast to an employer-sponsored plan, you won’t be limited to a small number of investment options.
You will want to analyze or examine the costs and fees associated with an IRA such as mutual fund internal expense ratios, money management fees, fees for maintaining an IRA and any fees incurred for rolling your money over.
However, remember that once you reach age 70.5 you must begin withdrawing funds in accordance with the IRS tables and can no longer defer taking contributions.
Lastly, be sure to check your state statutes to understand whether your money will be protected from creditors.
To rollover or not rollover? It all comes down to determining your goals and objectives.