Reaching Retirement Goals With IRAs
- You can probably make an IRA contribution, even if you participate in an employer sponsored-retirement plan.
- The Roth IRA is an attractive retirement account if you meet the income thresholds.
- You may benefit from the tax-deferred growth potential of a traditional IRA as long as you are still working and under the age of 70 1/2.
Tax-advantaged accounts for retirement investors
Getting ready for the day you can retire takes equal parts discipline and financial savvy. Meeting your annual savings goal is the first step. If you have that covered, good job — but you also need to make the most of your tax-advantaged accounts too.
Tax-advantaged accounts are favored for retirement investing. Your account may grow faster without the impact of paying taxes each year on the potential growth in your portfolio. As long as you (or your spouse if married filing jointly) have earned income, you may be able to make a current-year IRA contribution and benefit from tax-advantaged potential growth.
One common misconception keeps some people from contributing. You may think you don’t qualify to make an annual IRA contribution if you already participate in an employer-sponsored retirement plan. Chances are, you still can.
There is a difference between contributing to an IRA and deducting your IRA contribution on your current year tax return. As long as you have earned income and have money to invest, there is probably an IRA that fits your situation.
Exploring the types of IRAs
Just about anyone with earned income can contribute to an IRA. Each type of IRA has its own set of rules and tax advantages.
Traditional IRA. You make pre-tax contributions to a traditional IRA. Your traditional IRA contribution may or may not be deductible. If you or your spouse is covered by an employer-sponsored retirement plan at work, you may not be able to deduct an IRA contribution from your current year income.
Your current year contribution to an employer-sponsored retirement plan — 401(k), 403(b), gov’t 457, a profit sharing or pension plan as well as SEP and SIMPLE IRAs — is already tax deferred. If you are covered by an employer-sponsored retirement plan, the phase-out range for deductibility depends on your modified adjusted gross income (MAGI) limits.
There is a difference between contributing to an IRA and deducting your IRA contribution on your current year tax return.
You (or your spouse if married filing jointly) must have earned income in order to make an annual contribution. You cannot contribute once you turn age 70 1/2. Your earnings are not taxed until they are distributed.
Roth IRA. You make after-tax, rather than before-tax contributions to a Roth IRA. Your income must be at or below (MAGI) limits in order to be eligible to contribute. You or your spouse (if married filing jointly) must have earned income in order to make a contribution. There is no age limit for contributing.
Also, you can convert a non-Roth IRA or employer-sponsored plan to a Roth. Be aware you will be subject to income tax liability on the taxable portion you convert. Roth IRA distributions of earnings are tax-free if you meet certain conditions.1
SIMPLE & SEP IRAs. Small business owners may use SEP IRAs and SIMPLE IRAs to provide a retirement plan for their employees. These plans are ideal for small businesses with a few employees. Employees can make traditional IRA contributions to a SEP IRA.2
Retirement Plan Distribution Options. If you change jobs or retire, one of the most important decisions you may face is how to handle the money you’ve worked hard to earn and save. You generally have four options for your retirement plan distribution:
- Roll assets to an IRA
- Leave assets in your former employer’s plan, if the plan allows
- Move assets to your new/existing employer’s plan, if the plan allows
- Cash out through what’s called a “lump sum distribution,” pay taxes and perhaps a 10% IRS penalty
Each of these options has advantages and disadvantages and the one that is best depends on your individual circumstances. You should consider features such as investment choices, fees and expenses, and services offered3.
It can be a confusing decision to make. Should you leave the funds alone or broaden your investments? Here are some things to think about:
- Compare the fees and expenses between the employer plan and IRA.
- Consider any differences between the services offered and when penalty-free withdrawals are available.
- Determine whether you need help making these investment decisions.
- Any special considerations regarding your employer stock.
- Timing of required minimum distributions.
- Protection of assets from creditors and bankruptcy.
Your Financial Advisor can help educate you regarding your choices so you can decide which one makes the most sense for your specific situation. Before you make a decision, speak with your current retirement plan administrator and tax professional before taking any action.
Note: Rolling over your retirement savings into a Roth IRA will trigger a tax liability on the taxable amount of the conversion.
IRA contribution limits and deadlines
The IRS rules determine how and by what date you can make IRA contributions. Whether your contribution is deductible or not, you generally, must make your IRA contributions by April 15 for the prior year. That means if you plan to make a 2015 IRA contribution, you must do so no later than April 18, 2016. IRA owners in Massachusetts and Maine have until April 19, 2016.
You must have taxable earned income to qualify to contribute to an IRA.
For the 2015 tax year, your total contributions to all of your traditional and Roth IRAs cannot be more than:
- $5,500 ($6,500 if you’re age 50 or older), or
- Your taxable compensation for the year, if your compensation was less than this dollar limit.
The IRS catchup provision permits people age 50 or older to contribute an additional $1,000 for a total of $6,500 currently. It is a good idea to maximize your catchup contribution to gain the full benefit of tax-deferred savings.
What type of earned income qualifies for an IRA contribution?
Earned income comes from compensation such as salaries, wages, tips, commissions, bonuses, taxable alimony, royalties, nontaxable combat pay and net earnings from self-employment. Eligible compensation must be from personal services currently rendered. You or your spouse, if filing jointly, generally must have taxable earned income to qualify to contribute to an IRA.
Review IRS Publication 590 for a comprehensive list of what counts as earned income and what doesn’t. Some types of income do not qualify including the following:
- Interest and dividends
- Rental income
- Pension or annuity income
- Deferred compensation
- Social Security
- Unemployment benefits
- Child support
Remember, if your earned income is less than contribution limits, you can only contribute as much as your earned income.
The IRS addresses many of the questions you may have about eligibility and contribution limits in Publication 590 found here:
- After you fund your annual 401(k) contribution, you can still fund your IRA.
- Ask your advisor which IRA is best based on your situation and income sources.
- Find out if you can deduct your IRA contribution. If not, you may still benefit from tax-deferred savings, or consider funding a Roth IRA.
1Traditional IRA distributions are generally taxed as ordinary income. Qualified Roth IRA distributions are federally tax-free provided a Roth account has been open for at least five years and the owner has reached age 59-1/2 or meets other requirements. Qualified Roth IRA distributions are not subject to state and local taxation in most states. Both may be subject to a 10% federal tax penalty if distributions are taken prior to age 59-1/2.
2Withdrawals are subject to ordinary income tax and may be subject to a federal 10% penalty if taken prior to age 59-1/2. For SIMPLE IRAs, the federal penalty increases to 25% if a distribution is taken prior to two years from the first deposit made into a participant’s account if under 59-1/2.
3Please keep in mind that rolling over assets to an IRA is just one of multiple options for your retirement plan. Each of the following options is different and may have distinct advantages and disadvantages.
- Roll assets to an IRA
- Leave assets in your former employer’s plan, if plan allows
- Move assets to your new/existing employer’s plan, if plan allows
- Cash out or take a lump sum distribution
When considering rolling over assets from an employer plan to an IRA, factors that should be considered and compared between the employer plan and the IRA include fees and expenses, services offered, investment options, when penalty free withdrawals are available, treatment of employer stock, when required minimum distribution begin and protection of assets from creditors and bankruptcy. Investing and maintaining assets in an IRA will generally involve higher costs than those associated with employer-sponsored retirement plans. You should consult with the plan administrator and a professional tax advisor before making any decisions regarding your retirement assets.
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