Diversified Tax Tidbits by MARK A. BURNS
Last month we discussed the general rules about who is eligible to contribute to each type of IRA. Now we will discuss how to maximize tax savings opportunities that may be available to you (cash flow permitting).
First, if you are not eligible to get a tax deduction for putting funds into a Traditional IRA (TIRA), but you are eligible to put money into a Roth IRA, then you should take advantage of the Roth. But if you can get a tax deduction for a TIRA and can also do a Roth, then the question becomes which is better? (Please refer to last month’s column for a refresher on some of the basic rules about contributions and withdrawals). Here is how we generally advise our clients:
- If you are in the 15-percent federal tax bracket or lower, then the tax benefit you will get upfront is minimal so we recommend Roth.
- But if you are in the 25-percent or higher tax bracket, then go for the higher tax deduction benefit now with the TIRA.
- Finally, if you cannot take advantage of either a deductible TIRA or a Roth (i.e., income too high for both), then your only choice is to put money into a Traditional IRA but not get a tax deduction for it. (i.e., nondeductible IRA).
Now let’s discuss withdrawals out of these two types of IRAs.
Roth – Your own contributions can always be withdrawn on a fully tax free basis. So it is only the earnings on your contributions that need to be addressed for tax treatment. The earnings are also tax free if you make the withdrawal after age 59 1/2 and at least 5 years after the Roth account was opened. If you don’t meet both of those tests, then the earnings are fully taxable at your regular tax rate, plus potentially a 10-percent penalty.
Traditional IRA – If you have not made any nondeductible contributions over the years, then all distributions are fully taxable at your regular tax rate, plus a 10-percent penalty if you are under 59-1/2. If you have made some nondeductible contributions, then a pro rata portion of each withdrawal will not be taxable.
Two additional issues to be aware of:
- Once you reach age 70-1/2, you are required to take a minimum amount out of your TIRA each year (Required Minimum Distribution or RMD) based on an IRS formula.
- Rollovers – You are generally allowed to transfer funds from an existing TIRA or Roth into a similar account at a different financial institution with no tax implications.
The above is a very general summary of what can be a very complicated subject. Each person’s particular situation can be unique. Always consult a tax professional if you are uncertain about how tax matters might affect you.
Mark A. Burns, M.B.A. is a C.P.A. with Diversified Financial Solutions PC in Southbury. He can be reached at 203-264-3131 or Mark@DFSPC.biz.
