SORTING THROUGH IRA OPTIONS

Once upon a time not so long ago, retirement planning depended heavily on an employer sponsored defined benefit pension (monthly pension check) and Social Security retirement benefits. The concept of lifetime employment with a single employer, however, is largely a thing of the past, which also makes old style pensions a thing of the past. The fate of the Social Security retirement program is uncertain. Also, monthly Social Security benefits do not go as far as they once did. As a result, retirement planning in the 21st century requires the use of new strategies and tools. One common addition to a well thought out retirement plan is an Individual Retirement Account, or IRA. If you are contemplating the addition of an IRA to your retirement plan, you will need to decide whether a Traditional IRA or a Roth IRA is right for you. IRA Basics An IRA is a tax–advantaged retirement account that you own and control. You contribute to the account each year. The funds in the account grow, both through contributions and investment earnings, each year until you decide to start taking withdrawals. Earnings generated can compound on a tax–deferred basis until withdrawal. Think of an IRA as your own personal pension account that is funded by you. IRAs have grown in popularity over the last several decades, prompting them to evolve into several different varieties. The most commonly used of those being the so-called Traditional IRA and the Roth IRA. Traditional IRAs and a Roth IRAs Compared Both a Traditional and a Roth IRA operate on the same basic principle. However, there are some very important differences between the two. Understanding those differences will help you decide which type of IRA is right for you. Among the most important differences are:

• Eligibility age
  • Traditional IRA:You must be under age 70 ½ in the year the contribution is made.
  • Roth IRA:There is no age limit for contributions.
• Income
  • Traditional IRA:There are no income restrictions.
  • Roth IRA:You can only contribute to a Roth IRA if your income is below the current income threshold set each year by the IRS and based on your Modified Adjusted Gross Income (MAGI). For 2017, the income threshold for single filers started at $118,000 and ended at $133,000. For married filers, the income threshold starts at $186,000 and ends at $196,000. If your income is within that range, you can make a partial contribution.
• Contribution limit
  • Traditional and Roth IRA:The individual limit is $5,500 and a married couple has a limit of $11,000.
• Over 50 contributions
  • Traditional and Roth IRA:If you are age 50 or older in the year you contribute, you may be eligible to contribute an additional $1,000.
• Tax implications
  • Traditional IRA
    • Contributions: May be tax deductible.
    • Earnings: Are tax deferred until they are withdrawn.
    • Withdrawals: After age 59½, withdrawals are not subject to federal tax penalties, but may be subject to federal and state income taxes.
  • Roth IRA
    • Contributions: Are never tax deductible.
    • Earnings: Are not subject to federal tax penalties if withdrawn after age 59½ and held in the Roth IRA for at least five years. Earnings are tax-free if taken as part of a qualifying withdrawal.
    • Withdrawals: Contributions can be withdrawn at any time without penalty as long as they are held in the Roth IRA for five years, except under certain circumstances.
  • Distributions
    • Traditional IRA: Distributions must begin by April 1st of the year after which you turn 70½. Required minimum distributions are determined by dividing the prior year–end fair market value of the retirement account by the applicable distribution period or life expectancy.
    • Roth IRA: No mandatory age for taking distributions.

IRAs and Estate Planning Advantage Deciding whether a Traditional IRA or a Roth IRA is a better option for you requires you to consider not only the financial aspect of your choice, but also the estate planning repercussions. A Roth IRA can offer a significant estate planning advantage for some over a Traditional IRA. With a Traditional IRA, your estate may be required to pay both income and estate taxes on the value of the IRA whereas with a Roth IRA your estate may only incur estate taxes because you prepaid the income taxes when you made your contributions. Estate tax concerns currently typically only apply to persons with estates in excess of $5 million. For example, assume you had $100,000 in a Traditional IRA and withdrew the entire amount. You would effectively have $65,000 after tax, assuming a combined state and federal income tax rate of 35 percent. However, the full $100,000 would also be included in your taxable estate at death. If you had total assets in excess of the exclusion ($5.49 million in early 2017), there would be an estate tax of 40%. By comparison, if you had the same $100,000 in a Roth IRA, you have already prepaid the income tax with dollars that will not be subject to income tax. If you do not plan to use the funds held in an IRA during retirement, a Roth IRA may make more sense as a wealth transfer vehicle. With a Roth IRA, the funds held in the account can be transferred to a beneficiary who can then withdraw the funds without paying any income tax on the withdrawals. What If I Already Have a Traditional IRA? You may already have a Traditional IRA in place, either because your income has been too high for a Roth IRA, or simply because you were unaware of the estate planning options available with a Roth IRA. You may be able to convert, or “roll-over,” your Traditional IRA into a Roth IRA. You will have to pay income tax on the contributions. However, it may be worth considering given the wealth transfer benefits offered by a Roth IRA for larger estates. Both Traditional and Roth IRAs have complex rules and eligibility guidelines that are subject to change – and do change on a regular basis. To ensure you are making the right choice for both retirement and estate planning purposes, be sure to consult with legal and tax experts before deciding which type of IRA is right for you.