18 Jun The Basics: IRAs 101
The Basics: IRAs 101
By: Barry E. Haimo, Esq.
June 18, 2014
Background: An Individual retirement account (“IRA”) is a financial vehicle with many benefits to the person who created it as well as his or her family. Some of the benefits include:
*Asset protection from creditors
Ability to invest in the vehicle
There are two main types of IRAs: the Roth IRA and the Traditional IRA. In 2014, these are only available to people who earn less than a total amount of $129,000 for single filers or $191,000 for joint filers, and there are contribution limits tied to amount of income too. People who are disqualified (not eligible) from investing in an IRA because they earn more than this amount generally utilize permanent (universal) life insurance as a very comparable investment vehicle.
A Roth IRA is a special type of IRA whereby money or property may grow while minimizing income taxation. The money or property contributed to the vehicle has already been taxed (income tax). It is, therefore, free to grow tax-free in the IRA account. Subject to conditions and restrictions, the money may be withdrawn, including the gains, without being subject to taxation again, after reaching the age of 59.5. Thereafter, the owner of the account is required to make annual distributions (withdrawals) to him or herself. If the owner dies, the account nearly always designates a beneficiary or multiple beneficiaries. The beneficiaries, if properly advised, will elect to stretch out the account over time so as to reduce the amount of their required annual withdrawals over their longer expected lifetime instead of the previous and now deceased owner’s expected lifetime. Please note, however, as you would expect, there are stiff penalties for noncompliance, which includes early withdrawals (prior to 59.5 years of age).
A traditional IRA is similar to a Roth IRA in that the funds may be invested and may therefore grow inside the vehicle. Since it wasn’t taxed initially, it must be taxed on the back-end. Accordingly, in this type of IRA the growth on the money or property merely defers income taxation until it is withdrawn because the contributed money or property was contributed prior to being taxed (pre-tax). Similar to the Roth IRA, there is a beneficiary designation and the beneficiary or beneficiaries, if properly advised, may elect to stretch it out over their lives to reduce the amount of their annual required withdrawal. Again, there are stiff penalties for noncompliance. People often utilize both types of IRAs to hedge unforeseeable future changes in income tax rates. *Asset protection benefits recently changed in a United States Supreme Court case (June 2014). IRAs can and should be seriously considered in any estate and financial plan. Consult your financial planner and your estate attorney to learn more about wealth preservation and protection.
Other resources: IRAs in General: T. Rowe Price