Everything You Want to Know About Traditional IRA RMDs

Estimated reading time: 3 minutesIf you have been contributing to a Traditional IRA, eventually you will need to take yearly required minimum distributions (RMDs). The first RMD is required the year you turn 72, and they continue each year after that. Roth IRAs don’t require RMDs, since those contributions were made post-tax. RMDs on Traditional IRAs are the government’s way of ensuring they get their tax money from investors. Usually, investors make contributions to their IRA pre-tax, and they can write off the contribution on their taxes. When they take a distribution, they are taxed on the money based on their income levels. More frequently asked questions about RMDs are answered below.

How Do I Calculate My RMD?

The IRS uses a special table to calculate your RMD. Basically, they take the fair market valuation of your IRA and divide it by your life expectancy. You can view the charts here and make a worksheet outlining your RMDs near the bottom of the page. Some institutions allow investors to automatically withdraw the RMD from their account each year so plan owners don’t have to worry about figuring out the exact amount to withdraw each year.

Can I Withdraw More than the RMD?

Plan owners are allowed to withdraw more than their RMD each year, but this may bump them to a higher tax bracket at tax time. Extra distributions also do not count toward next year’s RMD.

What if I Have More Than One Account with RMDs?

If you have more than one account requiring RMDs, such as a Traditional IRA and a 401(k), then you can take your distributions from either account. The total amount must line up with what the IRS requires of you for the year, but you could take it all from one account or split it between both.

What is the Penalty for Not Taking an RMD?

If you didn’t take an RMD, or you missed the deadline, the IRS will penalize you up to 50% of what the RMD was. So, if you needed to take out $20,000, but missed the deadline, the IRS could penalize you $10,000. For more information on this topic, read our article What to do if You’ve Missed an RMD on an IRA.

Am I Taxed on My RMD?

If you made tax-deductible contributions, those contributions and your earnings will be taxed when you take your RMD. If you made contributions post-tax, then you won’t be taxed again on that portion of your distribution, but you will still be taxed on your earnings from the account.

What Can I Do with the Money if I Don’t Need it for Living Expenses?

If your RMD is more than what you need for living expenses, there are a few options you can do with the extra funds. The most popular options people choose are contributing the funds into a college savings plan or converting into a Roth IRA if they qualify.

How to Maximize the Growth of Your Investment IRA

Estimated reading time: 3 minutesWhen starting to plan for retirement, it’s important to start looking into tools that will help make the financial transition into retirement go as smooth as possible. Most people who are looking into ways that they can simplify the retirement process usually turn to an Individual Retirement Account. These are accounts that can have annual contributions, which can be tax deductible. Investments are only taxed when they are withdrawn from the account, but they are taxed in the same way that a regular income is taxed. There are certainly ways that people can get more out of an IRA account, which we will explain below.

The Earlier, The Better

IRAs grow when money is compounded. Investments can usually create more returns by reinvesting. If you give your money more of a chance to go through the cycle of compounding, the better chances of success for your IRA will be. This will allow your money to go through the compounding cycle without the impact of taxes taking over. Read more about this topic in our post How to Save for Retirement in Your 20s, 40s, and 60s.

Don’t Wait Until Tax Day to Contribute

Waiting until tax day is not a good idea. A lot of people who have IRAs only make contributions to their accounts when their taxes are done. Doing this denies the chance for your IRA to grow as much as possible over the course of the year. A contribution at the beginning of the year gives the IRA a longer time to compound. Instead of making one big contribution, experts recommend putting a small portion of your money into your account throughout the year because it will benefit you most in the future

Specialize by Using your IRA

It’s crucial to set investment goals. Having investment goals will help determine what goes into your account. Experts recommend funds that are trade exchanged because they have low expenses and the other fees aren’t as much as other accounts have proven to be if you’re looking into basic retirement plans. More advanced retirement plans have distribution across many different accounts based on the taxation, also known as an asset location. Bonds that earn an income should be invested into IRAs and other financial gains and assets should be put into accounts that can be taxed.

Not every strategy for stocks is something that can be considered beneficial. It doesn’t just depend on how much you get taxed from each account, but you also have to consider what your personal situation is at the time of investment and how much you are anticipating getting back from your investment. Assets that are considered inefficient are in favor of getting put into an IRA, but other funds, like index funds, should be put into an account that can be taxable. Lower-return funds don’t have a specific end location; they can go anywhere.

IRAs can also be used for way more than what you would expect. People often find themselves investing in many different specialized funds, such as foreign equities, real estate, or investments in stocks that are considered to be small-cap stocks. Speak to your financial advisor about the best course of action for you.

Simple Rules for Beginner IRA Investing

Estimated reading time: 3 minutesFor big companies, retirement investing isn’t something that employees have to put a lot of thought into. They have their 401(k) plans set up for you can you just have to decide a few of the smaller details. But when it comes to investing in an IRA, there is a lot more that goes into the decisions you have to make.

Not only are you getting the chance to decide between Roth IRAs and Traditional IRAs, you also get to decide what you want to invest in and how much you’re willing to invest. IRAs are unique because you are able to invest in a much wider variety of things rather than the limited investments you can make with other retirement plans. With this expanded selection of choices, however, there are a few things you’ll want to know when IRA investing. Below are some simple ‘rules’ per se to follow for beginner investors.

1. Know what risks you’re willing to take. When investing in anything, one of the most important things to remember is that there is always a risk that comes with it. Investing in high risk stocks can have a higher pay off, but there is also a chance that you could lose a lot of money. Investing in bonds is very low risk, but you also will have less of a reward. If you are willing to take some risks, make sure you know how far you are willing to go. It is also important to remember that the market is constantly changing, so the value of your investments will be moving fluctuating constantly.

2. Decide on an asset allocation that is right for you. Age can have a huge impact on how you invest. If you are just starting to invest and you are a long way off from retirement, you can take more risks because you’ll have more time for them to pay off. However, if retirement is quickly approaching, you’ll probably want to protect your assets. So, low risk investments will be better in this case. You can decide what percentage of your assets you want in different categories based on how much risk you are willing to take.

3. Using professional investors is okay. If you do not know much about the current market and selecting funds and stocks to invest in, it is okay to consult a professional. Not only will this save you time, it can also earn you a lot more money for retirement than if you were to invest yourself. While you may have to pay some small fees for this, the benefits of outsourcing will likely pay for itself several times over.

However you chose to invest, the biggest thing to remember is to think long term. Your retirement funds don’t grow overnight. The market is always changing. While your investments may rise and fall over the years, the general trend is always up, so don’t lose heart if the market is in a down trend. Investing in an IRA doesn’t have to be hard or scary if you keep yourself informed and follow these tips.

Are You Prepared for the Unexpected with Real Estate Investment Properties?

Estimated reading time: 3 minutesInvesting in real estate property is not like other retirement investments. It requires owners to be more hands-on and involved than typical stock options. Those hoping to use a self-directed IRA to invest in real estate will need to investigate market trends, learn the local real estate laws, and thoroughly inspect the property before investing. The plan owner will also need to evaluate potential liabilities stemming from the property, such as mold, types of tenants, older appliances, taxes, and more. The amount of work needed for such investments would surely scare anyone away from this option. However, the payoff for real estate investments can be enormous if executed correctly. One of the biggest decisions plan owners face when it comes to their real estate investment is the type of insurance it will have.

Investment Property Insurance

No matter where the property is located, it will need some type of insurance, or a combination of coverages. If the property is located in another state from where you live, extra precautions must be taken so that you completely understand the area and local safety requirements. Since these expenses must be payed from IRA, some investors may be apprehensive about purchasing adequate coverage and think a basic policy will be enough. However, having the wrong type of coverage could end up being more detrimental for your retirement funds in the long run if a disaster were to happen.

Some types of insurance property investors should look into are:

    • Flood insurance
    • Wind and Hail coverage
    • Third-party liability coverage
  • Replacement Cost

Even if a property is not in a designated flood zone, it may be wise to investigate further regardless. For example, Hurricane Harvey affected homes outside of the regular flood zone and 4 out of 5 homeowners didn’t have adequate coverage. Third-party liability coverage is another point often overlooked. If someone, other than you or the tenant, were to injure themselves on your property, would your insurance cover the damages? What is the policy regarding injury to pets or destruction caused by pets? These are the little details plan owners must be wary of before making a real estate investment.

There are still other points to consider as well. A standard homeowner’s policy requires that the building be occupied during a claim. If no tenant was residing in the space at the time of the claim, or it was vacant for at least 30 to 60 days, the insurance company could deny paying on the claim. If the investor decides to renovate the property or update a few features, a general homeowner’s policy may not cover liability for the builders. This may be an extra expense for a building project that owners will need to include in the total budget.

While setting a realistic budget is essential for real estate investments, the one area investors will not want to compromise is insurance coverage. After all, this is your hard-earned retirement money and it should be guarded with the utmost care.

Potential Benefits of Investing in Notes in an IRA

Estimated reading time: 3 minutesFor investors who want in on the real estate game, but don’t want the headache of owning a property, real estate notes are often a good compromise. Don’t get us wrong, notes do require a bit more work than the average investment, but there are plenty of options to fit anybody’s budget and time commitment. Below we will discuss the details of notes and some of their potential benefits.

What are Real Estate Notes?

In short, a note is a promise to pay back a sum of money under stipulations outlined in a contract. When a homeowner has stopped making payments on their mortgage, typically have very few options before the bank is forced to foreclose on them. However, an investor can jump in, purchase a note, and act in place of the bank over the homeowner’s mortgage. The investor can work out a more favorable repayment strategy for the homeowner that also benefits the investor with the interest payments.

The investor can keep the note until the loan is payed off, at which point the investor will not be receiving payments or making money on the property anymore and must find another investment. Or, the investor can sell the renegotiated note to another investor for a profit. If the homeowner fails to pay under the negotiated contract, the note investor can foreclose on the homeowner and either sell the property or turn it into a rental property.

Investors who may not have enough money to purchase an entire note may have the option to buy fractions of a note through a hedge fund. Investors can also use this strategy to invest in multiple properties at once, all potentially having different statuses, locations, and other risks. For more information about promissory notes, click here.

Active or Passive Investments

There are two types of notes investors can choose from: performing and non-performing. Performing notes are ones in which the borrower/homeowner is caught up on the payments and is regularly paying on time. These are lower-risk but may also return lower reward than a non-performing note. Non-performing notes are one in which the borrower/homeowner is not making regular payments and may require a renegotiated contract or initiate the process of foreclosing. These often involve large sums of legal fees in the beginning but can yield high rates of return once the process is settled. If the property ended in foreclosure, the investor would then own the property and would be responsible for selling or renting it out at that point. Any responsibility of the note holder can be outsourced, but doing so also means lower returns in the end.

Investing in notes has become much easier now that the public can find investment opportunities online and start seeing returns by the end of the month. However, just like with any investment, notes require due diligence on the part of the investor. There are scams online, and not every note is a great deal. Investors should complete ample research and talk to a note specialist before investing retirement funds into one. As long as investors understand the risks involved and exit strategies, notes are a diverse group of investments that anyone can utilize depending on their preferred investment involvement level.

Can a Non-Working Spouse Have an IRA?

Estimated reading time: 3 minutesSince it’s not possible to have a “joint” retirement account, like a joint bank account, there are ways that both spouses can own an IRA, even if one is not employed. Normally to open an IRA, one must be earning taxable income. It does not matter how old a person is or how much they make, as long as it is taxable. The only exception to this rule is something called a Spousal IRA.

Basic Rules for Spousal IRAs

If only one spouse is earning taxable income and the couple files their taxes jointly, the working spouse can use their income to contribute to both their own account and their spouse’s account. The benefit to this is that the couple can effectively double their retirement savings by utilizing this advantage. In order for the working spouse to contribute maximum amounts ($6,000 for 2021, or $7,000 if older than 50) to each account, they must earn more than $12,000 (or $14,000 if older than 50) that year. The IRS won’t allow savers to contribute more than what they earn in taxable income into retirement accounts. If a person earns $8,000 in taxable income in a year, they could contribute the maximum amount into one account, and then contribute the remaining $2,500 into a Spousal IRA. However, if a person earns more than $12,000, then they can contribute the full amounts to each account.

Who Owns the Spousal IRA?

One point to keep in mind is that the Spousal IRA will be in the name of the non-working spouse, even if they don’t directly contribute anything to it. This means, if the couple were to divorce, they would have the right to the money, or at least half depending on the agreements outlined in the divorce. However, if the working spouse made a contribution to the account before the couple divorced in the same year, the non-working spouse must remove the funds or be penalized since they earned no income to justify the contribution. They will also have the right to list beneficiaries on the account in the case of death. For couples who do not agree on beneficiaries, this could be a risk. However, for most couples, having the extra money in retirement is a blessing that far outweighs the risks.

Traditional vs Roth Spousal IRAs

Just like normal IRAs, the Spousal IRA can be set up as a Traditional IRA or a Roth IRA. There are specific eligibility rules for each type of account. For instance, couples must earn below the maximum income levels to contribute to a Roth IRA, and savers are only allowed to contribute to a Traditional IRA up to age 72. Traditional IRAs also require minimum distributions at age 72, while Roth IRAs do not require distributions at a certain age. For more information on the difference between Traditional and Roth IRAs, click here. Always consult a financial professional before opening a retirement account to ensure you are choosing the best type for your personal situation.

Three Ways a Roth IRA Could Be for More than Retirement

Estimated reading time: 3 minutesWhen people think about IRAs, they typically associate them with retirement. After all, that is what they were designed for. However, some investors don’t realize that funds from a Roth IRA can be used for other expenses that may arise before retirement. Below we will explain the three main categories people use their Roth IRA funds for besides retirement.

College Expenses

Student debt is now the second leading consumer debt category in the country, right after mortgage debt. The bill on student debt is even higher than for credit card or car loan debt! With the high interest rates student debt attracts, it can sometimes feel as if student loans will never be payed off.

Luckily, funds from a Roth IRA can be used to pay for school expenses, and some parents use their IRAs as a backup college fund for their child. If the child doesn’t attend college, or they have other means of paying for school, then the parents still have that money for their retirement. Although savers can pull contributions out penalty-free after the account has been open for 5 years, higher education expenses still count as a qualified distribution, so account owners don’t have to worry about paying a penalty if they don’t meet the distribution requirements. Funds can be used for the plan owner, their spouse, their children, or their grandchildren.

First-Time Home Purchase

Another exception for the early distribution rule is for first-time home purchases, builds, or rebuilds. If both spouses own an IRA and are both first-time home buyers, they could each pull $10,000 from their accounts for a total of $20,000 for their new home. The term “first-time home buyer” is slightly misleading, though. As long as one or both spouses have not owned a home for two years prior to the home purchase, they count as first-time home buyers. However, there is a $10,000 lifetime limit to this loophole for each individual, so buyers can’t take advantage of their retirement accounts forever.

Emergency Fund

Instead of contributing to a traditional savings fund, where the interest gained is pennies for every thousand dollars, some people use their Roth IRA as a place to hold and quickly grow an emergency fund. Roth IRAs typically have better returns than savings accounts, but it may take longer to receive the actual funds if an emergency arises. In this case, it’s wise to have 3-6 months’ worth of accessible funds available for short-notice emergencies and save the rest into a Roth. This way, you can still benefit from higher gains and have a bigger retirement account if you don’t end up using the funds in the Roth for an emergency.

While most financial advisors would recommend not touching retirement money until retirement, there are special circumstances that may cause one to consider using Roth funds for other purposes. Always consult a financial expert before moving money around or pulling from your Roth IRA to avoid any unnecessary penalties.

What is the Penalty for an Early Withdrawal from an IRA?

Estimated reading time: 3 minutesIf you’re asking this question, then you’re most likely needing a financial boost and are wondering if your retirement funds are an option. While most financial advisors would recommend never touching your retirement funds unless in a true emergency, there are some circumstances where you may avoid penalty on an early withdrawal. Before discussing these, we will explain how an early withdrawal can hurt you more than just in penalties.

Penalties, Taxes, and Other Losses

If you take a distribution from your Traditional IRA before 59 ½ or take a distribution from your earnings in a Roth IRA before having the account for at least 5 years or age 59 ½, whichever comes later, then you will incur a 10% penalty on the distribution amount. So, if you take a $10,000 distribution, $1,000 will automatically go toward paying a penalty. Note, distributions on your Roth contributions are penalty-free at any time.  

Besides the 10% penalty, you will have to also pay taxes on the amount distributed from a Traditional IRA. Be careful because the distribution counts as taxable income, and it could bump you up to a higher tax bracket depending on the amount withdrawn. You may also have to pay income tax on distributions made from a Roth IRA under certain circumstances. We’ll cover these in more detail below.

If those two points aren’t enough to scare you into keeping your retirement money where it’s at, consider the compounded interest you will lose out on if you take a distribution before retirement. Using the $10,000 example, in just 10 short years with a 5% interest rate that money could have grown to nearly $16,500 without any additional contributions. In 20 years, the number reaches to $27,000.

Remember, distributions aren’t always easily replaceable. Both Traditional and Roth IRAs have contribution limits of $6,000 per year (or $7,000 if you’re are 50 or older). This means you will only be able to replace about half of your distribution in the $10,000 example by the end of the year, if you haven’t met the limit already.

Exceptions to the Early Withdrawal Penalty

Luckily, there are a few exceptions to the 10% penalties, but you still may owe taxes and lose out on the compounded interest on your distribution. You can avoid the penalty and the taxes for a Traditional IRA or a Roth IRA distribution if you have had the Roth IRA for 5 years or more and:

    • Are 59 ½
    • You have suffered permanent or total disability
    • You are using up to $10,000 in a first-time home purchase
  • You are inheriting the IRA from a deceased relative

You can avoid the penalty, but still owe taxes on a Traditional or Roth IRA if:

    • You are using the funds for a qualified education expense
    • You haven’t had the account for at least five years, but you meet one of the criteria from the previous list.
    • You are taking substantially equal distributions over a period of time
    • You are using the funds to pay a medical expense that exceeds 7.5% of your AGI
    • You are using the funds to pay for health insurance while unemployed.
  • You are a member of the military and are taking a qualified reservist distribution.

Two last points to keep in mind. Rollovers do not count as distributions as long as you complete the transfer within 60 days. For the 5-year Roth rule, each contribution includes its own time clock. So, the most you can distribute in earnings is whatever was earned from the funds from at least five years ago, if you are younger than 59 ½ that is.

What is a Backdoor IRA?

Estimated reading time: 3 minutesRoth IRAs are fantastic ways to grow your retirement tax-free and access contribution funds at any time. However, not everyone can contribute to one. The contribution limits on a Roth IRA vary based on income and marital status. The most someone can contribute to a Roth IRA is $6,000 per year (as of 2021). This limit starts to taper off the higher in income you go, and eventually reaches $0 when you earn too much to qualify for Roth contributions. As of right now, however, there is a loophole of sorts to these limits with what is called a “backdoor IRA”.

What is a Backdoor IRA?

If you earn too much to contribute to a Roth IRA, you can still contribute to a Traditional IRA, and then roll over the funds into a Roth IRA. There are no age limits or income limits on a rollover. Keep in mind, however, that recent changes to IRA laws bar anyone from recharacterizing their rollover back to a Traditional IRA once the transaction is complete. Rollovers are final, so proceed with caution.

Remember, Roth IRA contributions are made post-tax, so rolled over funds from a Traditional IRA that were made pre-tax will be subject to taxation that year. If your investments lose money, and with no option to recharacterize, you may not have enough funds to pay the taxes owed and be on the hook for the deficit.

What are the Benefits of a Backdoor IRA?

Now that congress has restructured the tax brackets, you may qualify for a lower tax bracket than you were previously. If so, this is a great time to roll over your funds into a Roth IRA, so you pay the lower taxes now. Congress can change tax brackets again in the future, so it’s wise to take advantage of the lower taxes if you can swing it.

Distributions upon retirement for a Traditional IRA are taxed at the tax bracket you qualify for at the time. If you believe you will be at a higher tax bracket at the time you need to take distributions from your Traditional IRA, then you may consider making a rollover to a Roth IRA. Roth IRAs don’t require any minimum distributions at a certain age, so you can keep growing your funds as long as you need. Roth IRAs also allow for distributions on contributed money at any age penalty-free. Having investments in a variety of accounts, including Roth IRAs, allows more flexibility in retirement and helps diversify your portfolio.

How to Do a Backdoor IRA Conversion

There are two methods for completing a backdoor IRA.

Method One: Convert your entire Traditional IRA into a Roth IRA.

Method Two: Sell shares from your Traditional IRA and transfer those funds into a Roth IRA.

Remember, this strategy is only beneficial if the taxes you will save outweigh the costs of the transfer, including any fees associated. Always consult your financial advisor before moving funds from a Traditional IRA into a Roth IRA.