UPDATE FROM THE OFFICES OF CAROL McATEE & ASSOCIATES, CPAS, St. Petersburg, Florida

Carol McAtee & Associates, CPAS

 

                                              Traditional  IRA vs Roth IRA

Are you confused about your choices for deferring taxable income? Is it better to defer now or contribute to a post-tax IRA which then lets you grow your retirement money tax free?

Many factors can contribute to this decision including your age, taxable income bracket or other retirement options.

There are many software tools available to help you with these choices. You can get help from your financial advisor or there are many online software tools such as the Vanguard calculator which determines your net benefit after taxes.

What is a Roth IRA?

A Roth IRA is an individual retirement arrangement. It is a personal savings plan that gives you tax advantages for setting aside money for retirement. An account must be designated as a Roth IRA when opened.

What is a SIMPLE IRA?

A savings incentive match plan for employees (SIMPLE) plan is a salary reduction between you and your employer that allows you to choose to reduce your pay by a certain percentage each pay period, and have your employer contribute the salary reductions to a SIMPLE IRA on your behalf. All contributions under a SIMPLE IRA plan must be made to a SIMPLE IRA, not to any other type of IRA. The SIMPLE IRA can be an individual retirement account. If your employer maintains a SIMPLE IRA plan, you must be notified, in writing, that you can choose the financial institution that will serve as trustee for your SIMPLE IRA and that you can roll over or transfer your SIMPLE IRA to another financial institution.

What is an IRA?

An IRA is an individual retirement arrangement. It is a personal savings plan that gives you tax advantages for setting aside money for retirement. An IRA is referred to as a Traditional IRA if it is not a Roth IRA or a SIMPLE IRA. Traditional IRAs include SEP IRAs.

Roth IRA tax advantages and rules compared to a Traditional IRA:

  •  Contributions to a Roth IRA are not deductible. Active participation in an employerplan is irrelevant. Contributions to a Traditional IRA may be fully or partially deductible subject to whether you are covered by an employer retirement plan.
  • If certain requirements are satisfied for your Roth IRA, qualified distributions are taxfree. Amounts in your Traditional IRA (including any earnings or gains) are taxed upon distribution.
  • Can withdraw Roth IRA contributions any time for any reason without owing taxes or penalties. Early distributions from a Traditional IRA (before you are age 59½) may be subject to a 10% additional tax if no exceptions apply.
  • Contributions can be made to a Roth IRA after the participant reaches age 70½. The required minimum distribution (RMD) rules do not apply. Distributions are not required until death of the participant. However, contributions are not allowed past age 70½ to a Traditional IRA and required minimum distributions begin after age 70½.
  • Contributions are not allowed to a Roth IRA when modified adjusted gross income(MAGI) is above certain limits. There is no limit on how much you can earn and still contribute to a Traditional IRA, however there may be a limitation on the amount deductible above certain income thresholds.
  • You cannot set up a SEP IRA nor a SIMPLE IRA as a Roth IRA.

Contact us for help in assessing your tax situation before making your investment choices. There are significant penalties for excess or ineligible IRA contributions.

Rollover of IRA funds:

There has been a change in the rules from the IRS regarding the withdrawal of funds from your Traditional IRA. The regulations state that any funds withdrawn from your IRA account are subject to income tax (and the 10% penalty if withdrawn before age 59 ½). There are several exceptions to the penalty if the funds are withdrawn for hardship, your first home, etc. However, you are still subject to ordinary income tax. If the funds are redeposited (or rolled over) within 60 days then there is no tax consequence and it is treated as if nothing happened. The regulations were originally interpreted to mean one rollover per IRA account. So, if you had several IRA accounts you could rollover the money from each account effectively having tax-free and interest-free use of the money.

However, all of that changed last year with a tax court case that now defines the  regulations to read one rollover per taxpayer. If you have subsequent rollovers from other accounts those are treated as a withdrawal and excess contribution to your IRA which is not only subject to the 10% penalty (if under age 59 ½ ) but an additional 6% excise tax.

So what does this mean? You have IRA accounts in Bank of America, Wells Fargo and Chase which are self-directed. Funds are withdrawn from Bank of America, used for 59 days and redeposited. You then withdraw funds from the Wells Fargo IRA account which are used for 59 day and redeposited. And so it goes. Prior to this court case this activity did not generate any additional tax scrutiny. However now – any withdrawals after the first withdrawal are not eligible for the rollover provisions and will be subject to ordinary income tax and any applicable penalties.

This is not a surprise we want to discover at tax time. Contact me if you have had multiple withdrawals from your IRA’s to determine the tax consequences.

 

 

If you have any questions about this topic or other tax related questions, please do not hesitate to contact us at 727-327-1999.

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER, OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER  PARTY ANY MATTERS ADDRESSED HEREIN.

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