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Many are familiar with the term individual retirement account, or (IRA) in the United States.
What may not be so obvious, however, is the flexibility this type of account provides for a variety of planning and savings opportunities. In this piece, we will focus on traditional and Roth IRAs.
The Basics
The term IRA covers an assortment of account types (some of which may overlap).
Generally speaking, there are traditional IRAs (funded with pre-tax monies and are subject to the required minimum distribution requirements) and Roth IRAs (funded with after-tax monies and are not subject to required minimum distribution requirements).
In short, traditional IRAs help lower your taxes today, and Roth IRAs allow you to pay taxes now and have the funds grow tax-free going forward.
NOTE: There are other types of IRAs, such as inherited IRAs (spousal, spousal beneficiary, and beneficiary), SEP IRAs, and SIMPLE IRAs.
As a rule of thumb, it often makes sense to fund a Roth IRA in lower-earning years versus a traditional IRA in higher-earning years. The same idea applies to traditional and Roth 401(k) plans.
How Recent Legislation Has Reshaped IRAs
The rules governing IRAs have undergone changes with The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 and the Securing a Strong Retirement Act of 2022 (SECURE ACT 2.0).
The original SECURE Act moved the age at which required minimum distributions (RMDs) are required to begin from age 70 to 72. An RMD is the amount you are legally required to take out of your account and pay taxes on. SECURE 2.0 moved this back further to age 73 for those born January 1, 1951, or later and to age 75 beginning in 2033.1
Source: Slott Report; IRA RMD Age Made Easy.
It is important to note that you may still take distributions from your IRA penalty-free at age 70 ½. Roth IRAs continue not to be subject to an RMD requirement.
A Plethora of Planning Opportunities
IRAs provide a wealth of strategic planning opportunities.
One of the most common goals we hear from clients is a desire to lower taxable income. If someone is participating in an employer-sponsored plan, they may disregard the IRA as a planning tool.
However, anyone may contribute $6,500 to an IRA in 2023 (there is an additional $1,000 catch-up for those age 50 or older)2 if you have earned income. If you are covered by an employer plan you are subject to the following phaseouts:
Modified Adjusted Gross Income (MAGI). Married Filing Jointly (MFJ).
Source: fpPathfinder.com
If you are earning in excess of these amounts you may still contribute, but it will not be tax deductible (also known as a non-deductible contribution).
The Often Overlooked Spousal IRA
Another area of opportunity is the spousal IRA.
If a household has income under $218,000, a spouse can contribute to a traditional IRA even if he or she has no earned income, sheltering $6,500 (or more if you are over age 50) from taxes, provided you file jointly.
If your employer does not have a plan or if you have changed employers and are not yet eligible for the plan, funding a traditional IRA can be a useful tool.
A Deeper Look at Roth IRAs
You can also potentially fund a Roth IRA.
You may fund a Roth, traditional, or a combination of both IRAs up to the annual limit each year. For example, if your income allowed, you could fund $2,000 toward a traditional IRA and $4,500 to a Roth IRA for yourself, but you could not fund $6,500 to a traditional and $6,500 to a Roth.
Roth IRAs are subject to the following annual income limits:
Modified Adjusted Gross Income (MAGI). Married Filing Jointly (MFJ).
Source: fpPathfinder.com
A common frustration for many high-earning individuals is the inability to fund a Roth IRA due to the income limit. The traditional IRA (non-deductible) provides a solution.
Since there is no income limit on non-deductible contributions, an individual above the income threshold can make a non-deductible contribution (after-tax) and then immediately convert to Roth. This essentially achieves the same result as funding a Roth IRA with a few extra steps.
NOTE: What is considered a “backdoor Roth IRA” only works if there is not an existing IRA with tax-deferred assets. The IRS views all traditional IRA assets as one single IRA for tax purposes and applies a pro-rata rule to non-deductible and tax-deferred contributions in these conversions.
Understanding IRA Rollovers
IRA rollovers also provide unique planning opportunities.
You are allowed to make a one-lifetime rollover from an IRA to a Health Savings Account (HSA). The amount is limited to the maximum HSA contribution in the year the rollover occurs, but it can be advantageous as HSA funds are tax-free if they are used for qualified medical expenses.
Rollovers can also apply to 529 plans, a tax-advantaged savings plan designed to encourage saving for future education costs. Any unused 529 funds can be rolled into a Roth IRA for the beneficiary.
There are certain restrictions, such as:
- The 529 plan must have been open for 15 years.
- The amount that can be rolled over each year is limited to the annual Roth IRA contribution limits.
- The 529 balance cannot exceed a lifetime limit of $35,000.
Gifting and Charitable Donations
IRAs also provide gifting opportunities.
With the Qualified Charitable Distribution (QCD), distributions made from IRAs of those 70 ½ and older, that are also made directly to qualifying charities, are income tax-free.
Once you reach the age at which you must begin taking RMDs, these gifts to charities can be counted toward your RMDs, thus helping reduce your tax bill. There is an annual limit of $100,000 for the QCD.3
Request A Consultation
It is worth remembering that IRAs are multi-faceted tools that may play an important role in your financial planning, beyond what is discussed here.
If you are interested in learning more about IRAs or other financial instruments, please contact Roehl & Yi Investment Advisors and we would be happy to discuss your financial goals.
1Source: Kiplinger, https://www.kiplinger.com/retirement/bipartisan-retirement-savings-package-in-massive-budget-bill
22023 IRA Catch-Up Contribution Limit.
Roehl & Yi Investment Advisors, LLC (“Roehl & Yi”) is an SEC-registered investment adviser located in EUGENE, OREGON. This publication should not be construed by any consumer or prospective client as Roehl & Yi’s solicitation or attempt to effect transactions in securities or the rendering of personalized investment advice. A copy of Roehl & Yi’s current written disclosure statement as set forth on Form ADV, discussing Roehl & Yi’s business operations, services, and fees is available upon written request. Roehl & Yi does not make any representations as to the accuracy, timeliness, suitability, or completeness of any information prepared by any unaffiliated third party, whether linked to or incorporated herein. All such information is provided solely for convenience purposes and all users thereof should be guided accordingly. We are neither your attorneys nor your accountants and no portion of this material should be interpreted by you as legal, accounting or tax advice. We recommend that you seek the advice of a qualified attorney and accountant.
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