What IRA is Best for You?
Investing in an Individual Retirement Account – or IRA – can build confidence and security for the future. IRAs are a tax-deferred account that allows you to add to your retirement savings while deferring taxes on any earnings until a later date. With an IRA, it’s easier to grow and compound retirement funds quicker than through a taxable account because there is no tax drag.
An IRA can be set up through just about any bank, brokerage company, insurance firm or investment company. Willow Grove Advisors has years of experience assisting clients with the appropriate IRA to achieve their individual goals. As an independent wealth management firm with a global scope, Willow Grove Advisors works with you to structure IRAs around your personal and professional life to best fit your needs.
There are a number of different types of IRAs from which to choose, based on a variety of factors like tax considerations and when funds can or cannot be withdrawn from the account. You can select the appropriate IRA for you based on income, employment status, workplace offerings and other considerations. Typically, Willow Grove Advisors recommends these basic IRAs to deliver the best financial benefits.
What is a Traditional IRA?
Originally, there was just one type of IRA. Today, that structure is referred to as a “traditional IRA.” A traditional IRA is an individual tax-advantaged retirement savings account, with a potential upfront tax break, where you can save up to $6,000 (in 2020) coupled with an additional $1,000 catch-up contribution for investors over age 50 each year.
The annual deadline for contributing to a traditional IRA is Tax Day (typically April 15 each year). Following Tax Day, the annual contribution total resets to zero and you can begin contributing for the next year.
A traditional IRA is ideal for those actively employed, or your spouse is actively employed, who would like to save money for retirement tax deferred.
Earnings are not taxed if the money remains in the IRA. Investments grow tax free. Taxes on a traditional IRA are paid later – in most cases after retirement – when you are earning less money and therefore in a lower tax bracket. Withdrawals made in retirement are taxed at whatever the tax rate is at the time.
Traditional IRAs are also a good idea for workers who do not have a workplace-sponsored retirement plan. After tax dollars can be contributed to a traditional IRA to help secure their future and depending on the level of wages, the contribution may be tax deductible. A traditional IRA is meant for retirement, and withdrawals are penalty free only after you reach age 59 ½. You can contribute up to $6,000 per year until age 50, then $7,000 per year beginning at that age.
The important note with a traditional IRA is to make sure the funds stay in the account for the appropriate amount of time. Any withdrawals made from a traditional IRA before the age 59 ½ will result in a 10 percent penalty, along with taxes due on any tax-deferred contributions and earnings. (There is no penalty once you reach the year of that half birthday.)
However, you do not need to begin making withdrawals at age 59 ½. With a traditional IRA, you can wait for several years before accessing the funds. By law, you must begin making withdrawals on a traditional IRA account no later than April 1 of the year you turn 72 years old, or face penalties.
Contribution: After-Tax Money
Contribution Tax Deductible: Maybe
Taxable: Distributions are taxed as income
Required age of minimum distributions: 72
What is a Rollover IRA?
A Rollover IRA allows you to move funds from an old employer-sponsored retirement plan into an individual retirement account when you leave your place of employment. Rollover IRAs allow you to keep your retirement assets as tax-deferred without paying current taxes or incurring early withdrawal penalties and if you should choose to consolidate your retirement assets with your new employer’s retirement plan, you can roll the assets from the rollover IRA into the new retirement plan.
A Rollover IRA is commonly used to preserve an existing 401(k), 403(b) or other profit-sharing plan assets from a former employer, while keeping the possibility of consolidating your retirement assets in the new employer’s plan. There is no cap to the amount of money you can roll over.
By using a direct rollover, you have 60 days to take possession of assets and place them into another eligible retirement plan. After 60 days, 20 percent of the account’s assets may be withheld and not recovered until the employee files an annual tax return. If you have not reached retirement age (59½), you will also face early-withdrawal penalties on those assets.
Employees switching jobs can rollover an existing plan into a new retirement account with a new employer. When the rollover occurs, you can set up the new account as a rollover IRA, traditional IRA or a Roth IRA. The Traditional IRA assets can not be combined into a new employer’s retirement plan, only assets from a Rollover IRA. With a Roth IRA, taxes will be due since contributions are made pre-tax. Roth IRAs can only accept post-tax contributions. (More below.)
Contribution: Pre-Tax Money
Contribution Tax Deductible: Original contribution made pre-tax
Taxable: Distributions are taxed as income
Required age of minimum distributions: 72
What is a Roth IRA?
A Roth IRA differs from a Traditional IRA because contributions are not deductible. There is no upfront tax break and withdrawals in retirement are completely tax free. In fact, with a Roth IRA, you can withdraw the funds you contributed tax-free and penalty-free at any time.
The main appeal of a Roth IRA is the long-term benefit of tax-free income in the future. A Roth IRA is best for those who plan on being in a higher tax bracket at retirement age. In that scenario, you can withdraw funds in the future tax free – and not pay the high tax rate at the time. It’s also a good option for investors who might need to access the money prior to retirement age.
The maximum allowable contribution for a Roth IRA is $6,000 per year, or $7,000 for you more than 50 years old.
Eligibility to contribute to a Roth IRA is based on your income. To qualify for a Roth IRA, your Modified Adjusted Gross Income (MAGI) must be less than $139,000 per year for tax year 2020. Married couples and joint filers cannot exceed at MAGI of $206,000 for tax year 2020 to apply for a Roth IRA.
Those who earn too much for a Roth IRA can pursue a Backdoor Roth IRA. (More below.)
Contribution: After-Tax Money
Contribution Tax Deductible: No
Taxable: Distributions are are not taxed
Required age of minimum distributions: No Required age
What is a Backdoor Roth IRA?
A unique tax loophole allows high-income earners the opportunity to contribute to a Roth IRA through what’s known as the “backdoor.” Anyone making more than $139,000 as an individual earner (or couples earning more than $206,000 collectively) can save big money by investing in a Backdoor Roth IRA.
Contributing to a Backdoor Roth IRA is more complicated than a regular Roth IRA, but the benefits can be astounding. High-income earners can save tens or hundreds of thousands of dollars on taxes over years.
A Backdoor Roth IRA is produced by first contributing to a traditional IRA and then immediately moving, or converting, it to a Roth IRA to avoid paying taxes on any earnings or generating revenue that puts you over the contribution limit.
Having a Roth IRA allows you to keep growing your money for as long as you want. Those who have retirement income from multiple sources can benefit greatly by allowing funds to keep earning over a lengthy period.
To execute a Backdoor Roth IRA effectively, many investors choose a trusted wealth management consultant like Willow Grove Advisors to oversee the complex process and make sure everything is done correctly.
What is an Inherited IRA?
Sometimes, an individual can inherit an IRA or employer-sponsored retirement plan from a spouse or relative after the original owner dies. These types of accounts are called either an “inherited IRA” or a “beneficiary IRA.”
Inherited IRAs are often part of an estate or trust. A beneficiary must open an inherited IRA account in their name to receive the inheritance.
An inherited IRA is considerably different than other types of IRAs. First, contributions cannot be made to an inherited IRA. Also, there are specific rules for spousal and non-spousal beneficiaries. For example, the Setting Every Community Up for Retirement Enhancement (SECURE) ACT of 2019 recently made significant changes to regulations concerning heirs other than spouses. Under the SECURE Act, non-spousal beneficiaries must disperse the IRA within 10 years.
Spouses have more flexibility and do not have a requirement to disperse funds. A spouse can roll the inherited IRA assets into their own IRA. Under the SECURE Act, spouses can also defer funds until the age of 72.
What is a SEP IRA or Simplified Employee Pension Plan?
If you are a sole proprietor, business owner or earn self-employment income by providing a service you can contribute more to retirement through a SEP IRA than a Traditional IRA. Each year before tax day, you can contribute up to 25% or your income or $57,000 (2020) whichever is less, to your SEP IRA and receive a tax deduction.
As with the Traditional and Rollover IRAs it is important to note any withdrawals made from a SEP IRA before the age 59 ½ will result in a 10 percent penalty, along with taxes due on any tax-deferred contributions and earnings. (There is no penalty once you reach the year of that half birthday.)
However, you do not need to begin making withdrawals at age 59 ½. With a traditional IRA, you can wait for several years before accessing the funds. By law, you must begin making withdrawals on a traditional IRA account no later than April 1 of the year you turn 72 years old, or face penalties.
Savvy investors can save time, money and headaches by letting the pros take care of the minutia. Willow Grove Advisors provides sound advice, flawless performance and proven results. It also gives investors the security to enjoy retirement to the fullest.
Contact us today to discuss which IRA is right for you. From straightforward traditional IRAs and Roth IRAs to more complex Backdoor Roth IRAs or inherited accounts, we’re happy to answer questions and discuss your individual needs for the future.