IRA’s afford great income tax benefits, however, there are strict rules that must be followed to obtain these benefits. Further, there are recommendations to be considered to maximize these benefits.
There are two (2) types of IRA programs that offer different benefits; both programs should be reviewed to determine which program offers the taxpayer the best benefits. Some of the major points are as follows:
1. Traditional IRA – Contributions are deductible in the year of the contribution and income grows tax deferred. Income taxes are paid upon withdrawal. If the taxpayer takes a withdrawal prior to age 59½, then there will be an additional 10% penalty, unless the taxpayer meets certain limited exceptions.
Further, the taxpayer must start taking minimum withdrawals at 71½. If the taxpayer fails to do so, then there is a 50% penalty of the minimum required withdrawal annually.
At the taxpayer’s death, the IRA can rollover to a spouse without incurring taxes immediately. If there is no spouse, then income taxes generally must be paid immediately. However, there are ways to defer the taxes depending on (a) the beneficiary designation; (b) the way the IRA account was established and (c) the taxpayer’s withdrawal decisions.
2. Roth IRA – A contribution to a Roth IRA is not deductible in the year that it was made. However, all income grows tax free. The taxpayer will never have to pay income taxes on any permitted withdrawal.
There are penalties if the taxpayer takes a withdrawal before age 59½ (with certain limited exceptions). However, the taxpayer is never required to make a withdrawal from the account. This account can be transferred to beneficiaries without ever paying income taxes on the growth.
It is important to remember that IRAs are not for everyone. Taxpayers cannot deduct contributions to a Traditional IRA if they are covered by an Employer Sponsored Retirement Plan and have a modified adjusted gross income (“MAGI”) of over $61,000 (couple) or $41,000 (single). Further, the deduction phases out if the taxpayer’s MAGI is over $51,000 (couple) or $31,000 (single). If the taxpayer is not covered by an Employer’s Plan then there is no income limit. A taxpayer cannot use a Roth IRA if the taxpayer’s MAGI is over $160,000 (couple) or $110,000 (single). There is also a phase out of this if the taxpayer’s MAGI is over $150,000 (couple) or $95,000 (single).
The various IRA programs are complicated and have certain income and contribution limits and other requirements. Decisions you make when choosing a Traditional and/or a Roth IRA; establishing your IRA’s; making your initial withdrawal and naming your beneficiaries can greatly impact the income taxes applicable to those funds for the balance of your life or when you die. Further, both the Traditional IRA and Roth IRA will be included in the value of your estate for Federal Estate and New Jersey Inheritance Tax purposes. Since many taxpayer’s have a significant portion of their wealth in IRA’s, it is important to understand these tax consequences and to prepare for same.
We at WJ&L, LLP can help you review these programs and your choices in a comprehensive estate plan in order to maximize the benefit of your decisions and minimize the taxes (both income taxes and Estate/Inheritance Taxes). Further, we can help you plan for the inevitable “death and taxes” to minimize the effects on your family.