Wealth Management Blog

Posts tagged Ira

Which Type of IRA Do You Prefer?

By JJ Burns

March 10, 2013

There are two basic types of IRAs for retirement savers: the traditional IRA that has been around for decades and the Roth IRA, a more recent innovation. Each has pros and cons, so the choice often depends on your circumstances. To help you decide, here’s a brief comparison.

First, be aware that both IRAs share some common traits. The contribution limit for 2013 for all IRAs (of either type) is $5,500 (up from $5,000 in 2012). If you’re age 50 or older, you can kick in an extra $1,000. There’s no current tax on earnings from contributions within either IRA. And the deadline for contributions is the tax return due date for the year of the contribution, with no extensions permitted.

Now let’s examine the key differences.

1. Traditional IRAs.

If your modified adjusted gross income (MAGI) exceeds a specified annual level and you actively participate in an employer retirement plan, the deductibility of your contributions will be phased out. The phaseout for 2013 occurs for a MAGI between $59,000 and $69,000 for single filers, and between $95,000 and $115,000 for joint filers. If your spouse participates in an employer plan but you don’t, the phase-out range is between $178,000 and $188,000 of MAGI. Thus, many high-income individuals can’t deduct any part of their contributions.

When you take distributions during retirement, you’re taxed at ordinary income rates on the portion representing deductible contributions and earnings. Furthermore, if you’re under age 59½ when you take a distribution, you must pay a 10% tax penalty (unless one of several exceptions applies).

2. Roth IRAs.

Unlike with a traditional IRA, contributions to a Roth are never deductible, regardless of your MAGI. In addition, the ability to make full contributions to a Roth is phased out for 2013 for a MAGI between $122,000 and $127,000 for single filers, and between $178,000 and $188,000 for joint filers.

However, qualified distributions from a Roth in existence for at least five years are 100% tax-free. This includes distributions made (1) after age 59½, (2) due to death or disability, or (3) used to pay qualified first-time homebuyer expenses (lifetime limit of $10,000). Other distributions are taxed at ordinary income rates under “ordering rules,” which treat contributions as coming out first, then conversion and rollover amounts, and finally earnings. So a portion or all of a payout still may be tax-free.

Due to the back-end benefits, you might convert funds in a traditional IRA to a Roth, paying tax in the year of conversion. If it suits your purposes, you can “undo” the conversion by the tax return due date (including any extension).

Which type of IRA is best for you? Figure it out by factoring in all the variables. We can help you crunch the numbers.

Should You Consolidate Your IRAs?

By JJ Burns

July 9, 2012

Everyone’s financial situation is different, but people at various stages of life often share similar concerns. Here’s a question from a client we encountered under such circumstances:

“I am in my 60s and recently retired from my full-time job. Over the years, I’ve opened several traditional IRAs and a Roth IRA. Also, I have a ‘rollover IRA’ with funds from a 401(k) at a previous job. Should I consolidate all of these IRAs into one for tax purposes, or should I just leave things the way they are?”

While there is no real tax benefit one way or the other, there is a trap to watch out for if you do consolidate. Combining the assets of your traditional IRAs into a single IRA could provide a few advantages, however.

For starters, it may be more flexible and cost-efficient to have just one IRA, as well as relieving you of considerable clutter if you’re still receiving paper statements from all of your IRA custodians. Also, if one IRA has provided better investment returns than the other or offers other advantages, it might make sense to shift more funds to the IRA with those advantages. (Of course, past performance is no guarantee of future results.) And you may find it easier to coordinate your plans for retirement, and focus on your main objectives, with a consolidated IRA.

Moreover, consolidating accounts might help you avoid a complication that can arise when you start taking “required minimum distributions” (RMDs) from your traditional IRAs. The law mandates that you begin taking RMDs no later than Apri1 1 of the year following the year in which you turn age 70½. These withdrawals from your account, the amount of which is based on life expectancy tables, must continue annually for the rest of your life. If you have several IRAs, you’ll have to choose the source of your annual RMD. It can come from one or multiple IRAs. But no matter how you arrange the distribution, the IRS treats it for tax purposes as coming from all of your IRAs on a “pro-rata” basis.

Let’s say you have four IRAs with a combined value of $500,000, and this year you withdraw $20,000 from one of them. The applicable percentage is 4% ($20,000 divided by $500,000), so it’s calculated as if you had withdrawn 4% of the balance in each IRA. Consolidating your IRAs would eliminate any confusion.

Finally, be aware that you can’t commingle the funds in traditional and Roth IRAs. This is the trap we alluded to earlier. Because Roths have an edge over traditional IRAs—qualified Roth distributions are tax-free and you don’t have to take lifetime mandatory distributions—you wouldn’t want to put them together anyway. Should you consolidate all of your Roth IRAs? Many of the same considerations that apply to combining traditional IRAs also are applicable to Roths.