An IRA is best known as an account into which you can make an annual contribution and have the money grow tax deferred, or tax free in the case of a Roth IRA, until you withdraw it at retirement. Beyond the basic annual contribution, there are a number of uses and strategies for IRA accounts for you to consider based upon your situation.
Here are a few to consider.
The ability to contribute to an IRA account is dependent upon your having earned income. This is income from employment or self-employment. Income from things like investments or bank interest don’t count.
Alimony payments, however, count as earned income even if you are not working. You will be eligible to contribute to an IRA at a level that is the lesser of your actual earned income, including alimony, or the annual contribution limits of $5,500, or $6,500 for those 50 or over.
In situations where there is a nonworking or low-earning spouse, they may be eligible to make a full contribution to an IRA account even though their earned income might not otherwise qualify. This can be done through a spousal IRA.
Contributions can be made to either a traditional or Roth IRA up to the contribution limits for your spouse’s age. In order to take advantage of this, you must be married and file a joint tax return.
There are income limitations. If the working spouse earns more than $194,000 for 2016, the couple cannot take a deduction for a contribution to a spousal IRA. Between $184,000 and $194,000, there is a phase-out in the deductibility of any contributions to a traditional spousal IRA.
This is a great vehicle for a stay-at-home parent, for example, to continue to fund their retirement and potentially get an extra tax benefit.
Those who are age 50 or over at any point during the year are eligible to contribute an extra $1,000 annually to their IRA account. This is called a catch-up contribution and can be made to either a Roth or a traditional IRA.
When saving for retirement every little bit helps, so if you are contributing to an IRA, why not take advantage of this opportunity?
Roth IRA Conversions
Not only is a Roth IRA a powerful retirement vehicle, but it can also be a great estate-planning tool. Money in a Roth IRA can be withdrawn tax free and is not subject to required minimum distributions like a traditional IRA. A Roth IRA is a great vehicle to pass wealth on to a spouse or future generations tax free.
Traditional IRA accounts funded with pre-tax dollars will be subject to taxation at ordinary income tax rates in the year they are converted to a Roth.
One strategy might be to do a Roth conversion in a year when your other taxable income is lower than normal.
Another method is to do a conversion at a point when the stock market has experienced a steep decline in value. You will be able to convert a higher percentage of your account with a lower tax bite, due to the depressed value of your IRA account.
There is a popular strategy called the “backdoor” Roth conversion. Under this scenario you would make an after-tax contribution to a traditional IRA account and then convert this amount to a Roth. You would pay little or nothing in taxes. This is often touted as a way for those who earn too much to contribute to a Roth IRA. The phase-out for Roth IRA contributions starts at a modified AGI of $184,000 and goes until $194,000, above which no Roth contributions are permitted. But with a backdoor conversion, these limits can be overcome.
This works well as long as there are minimal or no dollars in traditional IRAs that were contributed on a pre-tax basis. If this is the case, the ratio of after-tax dollars to pre-tax dollars is calculated to determine how much of the conversion would be subject to taxes. In some cases, the pre-tax dollars can be rolled into an employer-sponsored retirement plan to alleviate the tax issue.
Use an IRA to Consolidate Retirement Accounts
An IRA is a great vehicle to consolidate old retirement accounts in one place. With people changing jobs more frequently than in the past, it is not uncommon for someone to have worked at three or more employers during the course of their career.
Each time you leave a job one of the key decisions is what to do with your old 401(k). Far too many people have old retirement accounts of various types strewn about here and there and not being properly managed. Consolidating these old accounts into a single IRA can make managing your retirement funds a bit easier and more efficient.
Open a SEP IRA
A SEP IRA is an IRA designed for those who are self-employed or who run a small business. As a practical matter they work best for the self-employed. They can get expensive if you have employees, because you must contribute the same percentage for your employees as you do for yourself.
A SEP IRA is funded with company contributions; no individual contributions are allowed as with a 401(k) or a regular IRA.
The limits are 25% of compensation with a maximum of $53,000 for 2016. The contribution level works out to be a bit less for those who are self-employed as a sole proprietor, due to the nature of the calculation.
SEP IRAs can be opened and funded up until the date you file your tax return, including extensions. Most custodians such as Vanguard, Schwab, T. Rowe Price and many others offer a SEP option. You can invest in most any type of investment you would use in an IRA, such as mutual funds, ETFs, stocks, etc. There is very little paperwork involved with a SEP IRA.
Qualified Charitable Distribution
Those who are at least 70½ and taking required minimum distributions (RMD) from their IRAs have the option to divert some or all of their RMD to a qualified charity, up to a limit of $100,000 per year.
If you don’t need the money and have charitable inclinations, this can be a good strategy. The portion donated to charity will not be taxable, but you cannot double dip and also deduct the amount as a charitable contribution.
This will reduce your AGI and could result in a savings on your Medicare premiums for the following year, depending upon your situation.
An IRA is a versatile retirement savings vehicle that extends beyond the ability to make an annual contribution. Know the rules in order to make the best use of your IRA.