How is an IRA Taxed?

Estimated reading time: 3 minutes

No matter what type of IRA you choose, you will eventually pay taxes on it. The question becomes, do you want to pay taxes up front or on the back-end at retirement? If you would rather pay taxes now (for example: you think your tax rate will be lower now than in the future), then a Roth IRA is the way to go. There are income restrictions for qualifying for a Roth, however you can get around this by rolling over funds from a Traditional into a Roth account. If you would rather pay taxes on your distributions upon retirement and enjoy a tax write-off now, then Traditional IRAs are right up your alley. This, of course, is the most simplified explanation. And we all know taxes are a bit more complicated when further investigated.

How Are Roth IRAs Taxed?

With Roth IRAs you don’t get a tax write-off when you make contributions, and you will owe taxes on your contributions based on your income and tax bracket at the time of the contribution. If you qualify for the Saver’s Credit, the amount you owe in taxes may be reduced.

One of the greatest benefits of a Roth IRA is that you do get to pull funds out tax-free under the right conditions. As long as a Roth IRA has been open for 5 years or you are over 59 ½, whichever comes later, you can take distributions on your earnings tax-free. Qualified home purchases and disability requirements also qualify for tax-free status.

If you haven’t had the account for at least 5 years or haven’t reached age 59 ½ yet, you may have to pay a penalty in addition to tax on certain distributions. Distributions on contributions are always penalty free, but not always tax free. Distributions on earnings may be subject to both tax and penalty depending on the circumstances. To learn more about Roth IRA withdrawals, click here.

How Are Traditional IRAs Taxed?

With Traditional IRAs, you can write off your yearly contributions if you meet certain income requirements, but you will owe taxes upon distribution at retirement based on your tax bracket at the time. Traditional IRAs require savers to start taking minimum distributions at age 72 that are based on how much is in the account and your age.

You may also be taxed and fined on Traditional IRA distributions if you withdraw funds before age 59 ½. Just like with Roth IRAs, there are extreme exceptions to this rule. However, one should consider all of the costs, including loss of compounded interest and taxes, before withdrawing early.

To pay taxes required on any qualifying distributions, you will just need to include your contributions and distributions on your yearly tax filing paperwork and use this to figure the amount owed. A tax professional can help you through the process if you are unsure.

One last note on retirement account taxes: You can make a distribution that moves you into a higher tax bracket. If it’s an RMD for a Traditional IRA, you may not have a choice. However, you may want to perform some calculations first to ensure you’re not paying more in taxes than you need to. Always consult your financial advisor before taking any out-of-the-norm distributions.

What is the Age Requirement to Contribute to a Roth IRA?

Estimated reading time: 3 minutes

With all of the different age limits and contribution limits on the various retirement accounts, it can be confusing keeping track of everything. Roth IRAs are a bit different than Traditional IRAs, including the contribution age limits. Read on to discover when and how much you can contribute to a Roth IRA.

Minimum Age Limit

Surprisingly, there is not a minimum age limit to Roth IRA contributions. The caveat, however, is that the owner of the account must earn taxable income in order to contribute to one. So, no, you can’t start one for your newborn grandchild. Once they start earning income, however, they can open and contribute to one. Unfortunately, their allowance for household chores doesn’t count as income in this sense. Typically, they will need to prove they were on payroll somewhere in order to count it as taxable income. If you owned a business and included them on your payroll for work they performed for the business, then this is usually deemed acceptable. Always double check with your local financial advisor first before employing this strategy.

Starting a Roth IRA for a teen’s first job is one of the wisest choices they can make with those dollars. Not only will their retirement money grow tax-free, but it can also grow to a couple hundred thousand dollars by the time they reach retirement age. Not to mention, they have the most expendable income at this age due to their lack of bills and other responsibilities. One of the “downsides” to this, however, is that they will have unlimited access to these funds once they reach age 18. If you want more control over when they can access their funds, a trust fund or naming them as a beneficiary on your own retirement account may be better options.

Remember, though, they can only contribute the maximum amount every year ($6,000 for 2021), or up to the amount they earned if it was less than $6,000. So, if they made $3,000 from their part-time fast-food job this year, they can only contribute up to $3,000 into their Roth IRA.

Maximum Age Limit

Unlike Traditional IRAs, there is actually no maximum age limits for contributions to a Roth IRA. As long as you are earning taxable income, you can contribute to your Roth—even if you’re 95! Contribution limits still apply. If you don’t have an income, but your spouse does, they can make contributions with their income into a Spousal IRA for you.

Also, you can make perform a rollover to a Roth IRA at any age, regardless of income. If you want to roll over funds from a Traditional IRA once you reach the minimum age for required minimum distributions on that account, you can. Just be aware that you may need to pay taxes on the funds rolled from a Traditional to Roth IRA, so always consult your financial advisor before making any moves. Due to restricted recharacterization laws, owners are no longer permitted to recharacterize a Roth rollover. Once you roll over, there’s no going back. Just another reason to consult your advisor before moving funds!

Self-Directed IRAs and the American Dream

Estimated reading time: 3 minutes

If you asked a group of people what the American Dream was, you would probably receive a different answer from each person. However, the responses would probably revolve around the central themes of having enough resources to cut down on everyday stresses and/or having a family to share life with. What attracts much of the world’s immigrants to the United States is the hope of success and prosperity, or just the opportunity to increase the quality of one’s life. While some people get lucky and are born into success or were born at the right time to have economical success come a little easier, success and prosperity are mostly gained through working hard and using your resources wisely.

It’s pretty clear that how one goes about achieving the American Dream is far different than it was 50 years ago, or even 30 years ago. A college degree isn’t a guarantee for getting a better job, and even the housing market is prone to major crashes, as we all witnessed in 2008. While we could debate for years over what the best strategies are for success, what we do know is that generations entering the work force now are having to be much more adaptable and innovative to make the American Dream into their reality. Many of these young workers are disillusioned with traditional 9-5 company jobs and are turning toward entrepreneurship.

We have all heard of the phrase “It takes money to make money,” and for the large part, you will need some resources to launch a business of your own. Utilizing Self-Directed IRAs is one way to gather the required resources. Unlike conventional IRAs, which limit the kinds of investments investors can make, Self-Directed IRAs open up the possibilities of investment to nearly anything, including your small start-up. Self-Directed IRAs call these “private placements”, and some entrepreneurs rely on investors to invest on them through this avenue.

Keep in mind, you can’t invest your own retirement funds into your business idea, and neither can your family or close friends. However, a handful of smart investors who see value in your idea might just provide you with the funds necessary to see it come to life. Usually investors are keenly aware that Self-Directed IRAs are inherently riskier than the safer stocks, bonds, and mutual funds they are used to. However, they also understand that with greater risk often comes greater reward.

Investors in Self-Directed IRAs like to stick with what they know or in a single industry in order to stay well updated on trends and news. They will likely vet potential investment opportunities before putting their money anywhere, and the process can sometimes take months of intense study. After all, not only are business owners relying on investors for launch money, but the investors are relying on the business for retirement money. In the right situation, investments in Self-Directed IRAs can turn out to be a win-win for everyone where all players get the sweet satisfaction of the American Dream in the end.

Tips for Investing Out of State

Estimated reading time: 3 minutes

With an investment like real estate, sometimes it makes more sense to take your money to a different state. Whether the market is slow, stagnant, or just not good in your area, many other places around the country are experiencing amazing growth that’s predicted to last a while. Those who get in on the action now can reap major rewards in just a few short years. Most of us can’t afford two mortgages to make this happen, but we do have available retirement funds at our disposal. Conventional IRAs don’t allow for real estate investments, but Self-Directed IRAs do. Like any investment, real estate investments take education, research, and analysis to increase your chances of coming out ahead. Learn more about how to wisely invest in out-of-state opportunities below.

Learn the Local Laws

Before investing out of state, it’s best to research and understand the local laws pertaining to your investment. If you are planning on investing in a rental property, you may want to check out the tenant-landlord laws in that state. What does the evection process look like and when are tenants liable for damages? Establishing a relationship with a real estate lawyer in that state is also a good idea in the event you need one or have a legal question about your property.

Complete a Market Analysis

Obviously, you will want to investigate the area and understand what the market projections look like in the next five and ten years, or however long you are planning on keeping the investment. Look for previous pricing patterns and learn what new businesses could be driving in jobs for particular areas. What are some of the economic decisions being voted on in the next election and how will they impact your investment? There are dozens of factors at play when it comes to real estate investments, and it’s important to understand most, if not all of them before jumping in. Learn more about Real Estate IRA Rules here.

Narrow Down Your Options

Once you’ve decided on a general area of where to invest, it’s time to choose a specific neighborhood or property. What types of renters does the neighborhood attract? Low income neighborhoods may score you a great deal at first but are more at risk for missed rents or vandalism. Check crime rate statistics and understand how quickly rental properties find qualified tenants in the area. Rural renting can sometimes prove more difficult, which means lost income potential for you.

Analyze Each Property

Just like inspecting your own home before purchasing, you will want to complete a full inspection of your investment as well. Will it need a lot of repairs before any income can be generated from the property? How long will repairs take? Besides initial repairs, it’s also important to be aware of future repairs. How old is the HVAC and water heater? What shape is the roof in and what is the seasonal weather like in the area? Don’t forget to calculate taxes, insurance, and property management costs into the equation as well.

Assemble a Trustworthy Team

Being out of state can be a hinderance when there are emergencies to handle. Having a trustworthy team on the ground can ease your anxieties but will also add to the expense of the investment. Some crucial players you will want to consider for your dream team are real estate attorneys, property managers, contractors, inspectors, insurance providers, and CPAs. Remember, you are essentially hiring them to work for you, so don’t take these decisions lightly. After all, your retirement funds are at stake!

Investing in real estate with a Self-Directed IRA is an exciting adventure no matter where you are. These tips will help you make a smart choice when it comes to choosing the right investment.

What’s Changing with Self Directed IRAs?

Estimated reading time: 2 minutes

While the Tax Cuts and Jobs Act threatened to make big changes with regard to retirement accounts, there were only a few small changes that actually made the final cut. Most of the investment rules and penalties stayed the same for the 2021 year. The changes that were made dealt with recharacterization rules, Roth account income limits, 401(k) contribution limits, Saver’s Credit income limits, and uses for 529 accounts.

Roth Recharacterizations

The biggest change in the Act was the limiting of plan recharacterizations. In the past, plan owners could convert their Traditional IRA to a Roth IRA as long as they qualified, and then revert back before the end of the year if they changed their mind. Sometimes assets lost value or the tax burden for the conversion ended up too much for the owner to bear, so they would convert their accounts back before the effects took place.

Plan owners will no longer be able to take advantage of this loophole starting with any Roth conversions made on or after January 1, 2018. For conversions that occurred prior to that date, plan owners may choose to recharacterize them back to a Traditional IRA on or before October 15, 2018.

Income Limits for Roth IRA

To contribute toward a Roth IRA, you must earn less than the maximum income limit for your category.

In 2021, there is also still eligibility limits for individuals to make contributions to a Roth IRA. Single taxpayers with a MAGI of $125,000 can make a full contribution, and those with a MAGI between $125,000 and $140,000 can make a lesser contribution. Married taxpayers can make full contributions where their MAGI is $181,000 (and lesser contributions for a MAGI between $198,000 and $208,000).

New Uses for 529 Plans

Parents and grandparents will be pleased that 529 plan funds, which traditionally have been set aside for college expenses, can now be used for K-12 expenses related to private, public, or religious schooling. There is a caveat, however. Plan owners can only use these funds for up to $10,000 in school-related expenses per year. Note that Coverdell ESAs had always allowed plan owners to use funds for K-12 schooling and there are no withdrawal limits. There are many more differences between 529s and Coverdell ESAs, however, so study these thoroughly before deciding on one or the other.

Self-Directed IRAs: Three Things You Should Know

Estimated reading time: 3 minutes

Self-directed IRAs are just what they sound like—IRAs that you call all of the shots for. These accounts allow for investments with larger rewards, but you will only reap them if you know what you are doing. Self-directed IRAs are inherently riskier than accounts controlled by a plan manager. Since you are the one choosing the investments, not just picking from a list, you will need to contribute research and prior knowledge into the process in order to play smart. Read on to learn more about what you should know about Self-Directed IRAs before starting one of your own.

Knowledge is Power

Most people who utilize Self-Directed IRAs stick with what they know. If they have a background in technology, or know a lot about real estate, they can make wise choices with those investments. Gathering as much information as possible, keeping up on the latest news in the industry, and checking projections are all ways to make the most of your investments. Remember, there are some restrictions for Self-Directed IRAs that can cost you in penalties. Avoid these at all costs.

Going into an investment blind could end up costing you big time, and you don’t want to be too risky with your retirement! However, the bigger the risk, the bigger the reward most of the time. Just keep in mind, there’s risk and then there’s calculated risk. Stay on the calculated side to avoid big blunders.

One Misstep Can Cost You Thousands

Not only do you have to be aware of the risk and rewards of each investment, but you also need to understand the total price as well. Some investments carry with them an added tax burden that investors should calculate into the total cost of the investment before purchasing. Just because these investments do have tax consequences doesn’t mean you should automatically write them off, however. The rewards for some outweigh the costs, but it’s important to at least be aware of them before you get yourself into a situation you weren’t prepared for. Typically, Self-Directed IRAs have lower management costs, so don’t forget to calculate in that piece as well.

Investment Opportunities are Abundant

Most retirement accounts have a list of investments that plan owners can choose from. Sometimes these options are just what you are looking for, and other times not so much. Self-Directed IRAs offer more room for experimentation and opportunities. If you have kept up-to-date on trends in your industry and see an opportunity that could pay off big time, a Self-Directed IRA is one way to make that happen. You can also invest in real estate, gold, private businesses, and tax liens with a Self-Directed IRA, which you can’t do with typical IRAs. However, like with conventional IRA accounts, you can choose between Traditional, Roth, SEP, SIMPLE, Individual 401(k), etc. for your plan type.

If you would like to diversify your portfolio or invest in something specific, you can use a Self-Directed IRA to accomplish your goals. As long as you understand the investment and calculate your risk, these types of investments can pay off handsomely.

How to Rollover 401k to IRA

Estimated reading time: 3 minutes

After leaving a job, you may be wondering what on earth you should do with your old 401(k) funds. There are a few options to consider, each with their pros and cons. Always consult your financial advisor before transferring funds, as they can offer advice on which type of transfer is best for your stage of life and how to move the funds hassle-free. Your 401(k) options include:

    • Keeping your funds where they are
    • Rolling the funds into an IRA or Roth IRA
    • Transferring the funds into your new 401(k)
  • Cashing out

If you keep the funds where they are, your old employer won’t make any matching contributions, and you may not be able to make any contributions yourself depending on your employer’s specific rules. You will also be limited to the plans they provide or the fees they entail, which you may or may not like. Consolidating your 401(k) funds into a plan of your new place of employment will keep things simple and all in one place. If you change jobs frequently, having multiple plans sitting at each old place of employment may get confusing.

Cashing out is usually only utilized as a last resort option. You may be subject to a 10% fee if you are younger than 55 or between 55 and 59 but still working. You can avoid the 10% fee if you are older than 59 ½ or you are between 55 and 59 but are retired. What you withdraw will also be counted as taxable income and may bump you to a higher tax bracket. If you need to supplement your income until you have a steady stream once again, most advisors suggest only withdrawing the absolute minimum necessary and rolling over the rest into an IRA.

Rolling Over a 401(k) to an IRA

If your employer writes a check directly to you for the funds in your 401(k), you will have 60 days to deposit those funds into a new qualified plan. Failing to deposit the funds within 60 days will result in taxation on the funds since it will be considered income, as well as a 10% fee if you are not 59 ½ yet. Furthermore, the IRS requires that your employer withhold 20% of the funds just in case you don’t make the deadline, so they are guaranteed their tax money. If you make the deadline, however, you should receive the 20% back at tax time. You can avoid all of this by doing what’s called a “direct transfer” from the 401(k) account into your new IRA account. This is usually done electronically as long as you have an account set up with a qualified institution already.

If you transfer a standard 401(k) into a Traditional IRA or a Roth 401(k) into a Roth IRA, everything should go smoothly. If you transfer a standard 401(k) into a Roth IRA, you will likely owe taxes on the amount. This may be advantageous if you are expecting the tax rates to be higher than they are now at your retirement since Roth IRA distributions are tax-free. Before converting, always seek the advice of your financial advisor.

What Is the Maximum IRA Contribution for 2021?

Estimated reading time: 2 minutes

Although the IRS has decided to keep contribution limits the same for retirement accounts this year as it was last year, they did raise eligible income levels for Roth IRAs to adjust for inflation and may even help more savers utilize Roth accounts. Here is a quick refresher on contribution limits and income restrictions:

IRA Contribution Limits

For both Traditional and Roth IRAs, savers may contribute up to $6,000, or $7,000 for people 50-years-old or older. Keep in mind, this is the total amount per person. If you have multiple IRAs, you are only allowed to contribute the $6,000 ($7,000) total between all of your accounts. The only exception to this is if you have a Spousal IRA, which allows the primary income-earner to contribute another $6,000 to an IRA of their non-working spouse. With the new age of cryptocurrency, you also need to freshen yourself up on the invest opportunities such as Bitcoin in Roth IRA.

Another caveat to retirement accounts is that you may only contribute the maximum amount as long as your income is at or above $6,000 per year. Otherwise, you can only contribute up to what your annual income is. For example, if you make $3,500 this year, you can only contribute $3,500 to a retirement account. Income counts as anything earned from salary, hourly pay, or profits from a small business. Passive income, such as earnings on an investment, do not count as eligible income.

Income Restrictions for Roth IRA Contributions

Since Roth IRAs allow you to pull out money tax-free, the government has issued income restrictions for who is allowed to contribute to these accounts. Here is a breakdown of these limits:

Single taxpayers with a MAGI of $125,000 can make a full contribution, and those with a MAGI between $125,000 and $140,000 can make a lesser contribution.

Married taxpayers can make full contributions where their MAGI is $181,000 (and lesser contributions for a MAGI between $198,000 and $208,000).

 

How Much Can You Contribute to A Roth IRA?

Estimated reading time: 2 minutes

Every once and awhile the IRS increases contribution limits or income limits for Roth IRAs. This year, while contribution limits are staying the same, income limits have increased for who is eligible to contribute to a Roth IRA. For 2021, eligible participants may contribute up to $6,000 toward their Roth IRA. If you are older than 50 you can contribute up to $7,000. Contributions can be made anytime until the tax filing deadline.

Earned Income Nuances

Earned income is defined as anything you made from salary, hourly pay, or profits from a small business. Basically, if it’s taxable it counts as earned income. If your earned income happens to be less than $6,000, you may only contribute up to the full amount of your earned income, not the full $6,000. Even if you make no money but your spouse does, you can set up a Spousal IRA and contribute the full $6,000 to both accounts as long as your spouse earns more than $12,000 in a year.

Contribution Strategies

There are a couple of different options when it comes to making contributions. You can contribute the full amount in one payment at any time during the eligible window. Another strategy is what’s called dollar-cost-averaging. This is where you spread your contributions out over the course of the year, whether that’s monthly or quarterly, to average your risks and rewards. By spreading out the contributions you may buy shares when they are priced low or high, but it will average your cost in the end. Since it’s difficult to know when prices will be low, if you contribute all at once, you may be unwittingly buying shares at their highest price point. Dollar-cost-averaging minimizes that risk.

Conversions

When converting funds to a Roth IRA, there are no contribution or income limits. Therefore, if you already opened a Roth account while you were eligible, you can roll over funds from another account into your Roth, no matter the amount. If you are no longer eligible for contributing directly to a Roth, you can use the “backdoor Roth” strategy to benefit from tax-free distributions at retirement. Keep in mind, however, that you will need to pay taxes on any untaxed funds converted and the funds may count as earned income that could bump you to a higher tax bracket. Always consult your financial advisor before converting funds from one account to another.

When Can You Withdraw from A Roth IRA?

Estimated reading time: 3 minutes

Although it’s best to wait until retirement to use your retirement funds, so you fully benefit from the compounded interest made on your funds, there are times when you may need to make a withdrawal to cover an unexpected expense. Roth IRAs are different from Traditional IRAs when it comes to withdrawal rules, so you will want to understand to rules and regulations related to Roth IRAs before taking out funds. Taking too much, for instance, could result in additional taxes and penalties. Here is a basic outline explaining when you can withdraw, and how much, from a Roth IRA.

Before age 59 ½

If you are younger than the age of retirement, you can still take withdrawals, but you will be limited on how much you can take. Roth IRA owners are allowed to make withdrawals on their contributed funds tax-free and penalty-free at any time. However, withdrawals on earnings will be subject to both taxes and penalties. For instance, if you have only had your account for one year, you made $5,000 in contributions, and it appreciated to $5,200, you could only withdraw the $5,000 without taxes or penalties.

If you are planning on withdrawing more than just your combined contributions, there are a few points to keep in mind. First, the five-year rule may save you from having to pay penalties or taxes. If you have had your Roth IRA account for more than five years, you won’t have to pay a penalty on your earnings withdrawal. Below age 59 ½, you will still be subject to paying taxes on your earnings withdrawal unless you meet any of the following criteria:

    • You use the funds for a first-time home purchase—up to $10,000 lifetime maximum
    • You pass away or become disabled
    • You use the funds to pay for unreimbursed medial expenses exceeding 10% of your AGI (7.5% for 2017-2018)
    • You use the funds to pay for medical insurance after losing your job
    • You use the funds to pay for higher education tuition for you, your children, or your grandchildren
    • You use the funds as a qualified disaster recovery assistance
  • The withdrawal is part of a substantially equal periodic payment plan—lasting for at least five years.

If you have had your account for fewer than five years, then you will still be subject to taxes, but not penalties on your earnings if you meet the above requirements.

Ages 59 ½ to 70

Again, Roth IRA plan holders can take distributions on their contributions at any time. However, within this window of time, you may be subject to taxes but not penalties on earnings if you have had your account for fewer than five years. After age 59 ½, if you have had your account for more than five years, you can take withdrawals on earnings without any taxes or penalties.

Age 70 ½ and older

If you have had your account for fewer than five years, withdrawals on earnings will be subject to taxes but not penalties. If you have had your account for more than five years, then you can withdraw earnings without paying any taxes or penalties.