• Bernhardt Wealth Management

Five Tax Tips for Your IRA

Since their establishment in 1974 with the passage of the Employment Retirement Income Security Act (ERISA), individual retirement accounts (IRAs) have become the backbone of retirement planning and savings for millions of Americans. And the number of households with either traditional or Roth IRAs continues to grow: in 2017, some 29% of households had IRAs, and by 2021, that number had grown to 37%. Through the years, IRAs have also been modified with the intention of improving their usefulness to account holders and also to offer additional tax-related options. Perhaps the most notable of these is the establishment of the Roth IRA in 1998, named after its sponsor, Sen. William Roth. Now, taxpayers have the option of deducting their IRA contributions from current income and paying taxes on withdrawals in retirement (traditional IRA) or foregoing current deductions and paying no taxes on withdrawals in retirement (Roth IRA). In both cases, compounding or growth in the IRA account is excluded from current income for tax purposes, allowing for faster compounding and growth until the funds are needed.

Given the importance of IRAs for so many Americans, it seems like a good idea to provide a refresher on some key aspects of IRAs as they relate to your taxes, both now and in retirement.

Taxation on funds in the account: Traditional IRA funds are not taxable until distributed (typically, in retirement), and Roth IRA funds are not taxed even on distribution. The choice between a traditional or Roth account is important, because taxpayers who believe they will be in a lower tax bracket at retirement may opt for the current tax deduction that comes with the traditional account. But some taxpayers may actually be in a higher bracket at retirement after allowing for the income from all available sources. For these individuals, the Roth account may be a better choice, since it allows them to pay taxes on the funds in their current, presumably lower bracket, and receive nontaxable income in retirement.

Transferability: The owner of an IRA account can transfer their IRA without tax consequences to their spouse (or former spouse under a divorce or separate maintenance decree). IRA accounts also carry a beneficiary designation, and this can be important for taxpayers who require estate planning to avoid undue taxation of the inheritance to be received by their heirs. Some grandparents, for example, may wish to name a grandchild as the beneficiary of their IRA accounts in order to simplify the passage of these assets to a younger generation. (Such considerations should always be discussed with the account owner’s tax expert, however.)

Income treatment of distributions, (traditional IRA): Generally, distributions from a traditional IRA are taxed as ordinary income at the time of withdrawal.

Income treatment of distributions, (Roth IRA): Roth IRA distributions are not treated as taxable income since they were taxed at the time they were deposited in the account.

Required minimum distributions: For traditional IRAs, account owners must begin taking required minimum distributions (RMDs) by April 1 of the year that the IRA holder reaches age 72 (if born after June 30, 1949; account owners born before that date must begin taking RMDs by age 70½.) RMD amounts are calculated based on the IRA holder’s life expectancy. In cases of a married couple where one spouse is more than 10 years younger than the other, clients can use their joint life expectancy to reduce the RMD. Roth IRAs have no RMD provision for the original account holder. However, Roth IRAs that are inherited by a beneficiary must generally be distributed within ten years of receipt by the beneficiary, unless the beneficiary is a spouse of the original account holder.

As a fiduciary wealth manager and financial advisor, Bernhardt Wealth Management is committed to keeping our clients current on all aspects of their retirement planning and accounts, including maximizing the tax efficiency of investments. To learn more, click here to read our article, “Better Late? Reasons to Delay Social Security Benefits.”

Buen Camino!

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