Our comprehensive glossary is designed to simplify and explain the complex world of Individual Retirement Accounts (IRAs) for both beginners and experienced investors. Whether you're looking to learn about the basics of Traditional IRAs, Roth IRAs, or Self-Directed IRAs, our glossary covers a wide range of essential terms, investment options, and tax implications.
Dive in and expand your understanding of IRAs to make informed decisions for your financial future. Trust 1031 Exchange Place to be your guide in the world of retirement planning.
Annual Contribution Limit
The Annual Contribution Limit refers to the maximum amount of money that an individual can contribute to certain types of accounts, such as retirement accounts (401k, IRA, etc.), Health Savings Accounts (HSAs), or education savings accounts (529 plans) in a given year.
These limits are typically set by governmental regulatory bodies such as the Internal Revenue Service (IRS) in the United States, and they can change from year to year based on inflation and changes to tax law. For example, the annual contribution limit for a 401(k) plan in the United States was $19,500 for individuals under 50, and $26,000 for individuals 50 and over (including a $6,500 catch-up contribution).
Exceeding these limits can result in tax penalties, so it's important to monitor contributions to these types of accounts closely.
Backdoor Roth IRA
A Backdoor Roth IRA is a strategy for individuals who want to contribute to a Roth IRA, but whose income exceeds the IRS's income eligibility limits.
Traditional Roth IRAs have income-eligibility restrictions, meaning that high-income earners are not allowed to contribute directly to them. However, there are no income limits for converting a Traditional IRA to a Roth IRA. This is where the "backdoor" method comes in.
The Backdoor Roth IRA strategy involves two steps:
- Contribute to a Traditional IRA: A person who earns too much to contribute directly to a Roth IRA can still contribute to a Traditional IRA, which has no income limits for making nondeductible contributions.
- Convert the Traditional IRA to a Roth IRA: The IRS allows people to convert Traditional IRAs into Roth IRAs, regardless of income. This process is often tax-free, especially if the conversion is done shortly after the contribution before any earnings accrue.
The term "backdoor" refers to the roundabout method of getting money into a Roth IRA. This strategy essentially allows individuals to bypass income restrictions, thus enabling high earners to enjoy the benefits of a Roth IRA, including tax-free growth and tax-free withdrawals in retirement. However, there are potential tax implications and complexities involved in this strategy, so it's often advised to consult with a financial advisor or tax professional before proceeding.
A beneficiary IRA, also known as an inherited IRA, is a type of retirement account that is acquired by the non-spouse beneficiaries of a deceased individual's IRA (Individual Retirement Account) or other retirement plan. These beneficiaries could be children, grandchildren, other non-spouse relatives, or even non-relatives such as friends or trusts.
The rules for how the funds in a beneficiary IRA can be accessed and taxed depend on several factors, including the type of the original retirement account, the age of the original account holder at the time of death, and the relationship of the beneficiary to the deceased.
The SECURE Act passed in the US in 2019 significantly changed the rules for inherited IRAs. Most non-spouse beneficiaries are now required to withdraw all funds from an inherited IRA within 10 years of the original owner's death, rather than over their own life expectancy as was previously allowed. This change can have significant tax implications.
For the most accurate and up-to-date information, you should consult a tax advisor or financial professional, as the rules can be complex and change over time.
"Catch-Up Contribution" is a term used in Individual Retirement Accounts (IRAs) and other types of retirement savings plans. It refers to the extra amount that individuals who are aged 50 or older are allowed to save in their retirement accounts.
The purpose of this provision is to help people who may have started saving for retirement later in life, or who have not been able to save enough, to "catch up" in their retirement savings. This is particularly important because retirement savings often grow tax-free, so the more you can save earlier, the more time your money has to grow.
The annual catch-up contribution limit for IRAs was $1,000, meaning that individuals aged 50 or over could contribute $7,000 in total to an IRA each year instead of the standard $6,000. However, these limits are often adjusted over time to account for inflation, so they may be different now.
Please check with the latest IRS guidelines or a financial advisor to get the most accurate and up-to-date information.
A Conduit IRA, sometimes also called a Rollover IRA, is a type of individual retirement account that is used as a vehicle to transfer funds from one retirement account to another without incurring any tax liabilities. This type of IRA is often used when an individual changes jobs and wants to move the money they have accumulated in their employer-sponsored retirement plan (like a 401(k)) to another retirement account.
The term "conduit" refers to the fact that these IRAs serve as a pathway for the funds, essentially acting as a conduit between the old retirement account and the new one. Importantly, a conduit IRA should only hold assets that have been rolled over from previous retirement accounts. If other contributions are made to the account, it could lose its status as a conduit IRA and could potentially have tax implications for the account holder.
Please note that the tax laws and regulations related to retirement accounts can be complex and subject to change, so it's always a good idea to consult with a financial advisor or tax professional for guidance specific to your situation.
The "contribution limit" refers to the maximum amount of money that an individual is legally allowed to contribute to their IRA in a given tax year. This limit is set by the Internal Revenue Service (IRS) in the United States, and it may be adjusted periodically to account for inflation and other economic factors.
The annual contribution limit for an IRA was $6,000 for individuals under 50 years old and $7,000 for individuals 50 years old and above. These limits apply to the total contributions an individual makes to all of their IRAs (including Roth and traditional IRAs) combined.
It's important to note that these limits can be subject to income restrictions, particularly for Roth IRAs, where the ability to contribute can be phased out at higher income levels.
To get the most current limits, it's always best to check the IRS website or consult with a financial advisor.
Conversion typically refers to the process of moving funds from a traditional IRA to a Roth IRA. This is known as a Roth IRA conversion.
Here's a bit more detail:
- Traditional IRA: This type of IRA offers tax-deferred growth, meaning you don't pay taxes on your contributions or investment gains until you start taking distributions in retirement. However, these distributions are then taxed as ordinary income. Also, depending on your income and whether you have a workplace retirement plan, your contributions may be tax-deductible.
- Roth IRA: This type of IRA offers tax-free growth, meaning you pay taxes on your contributions up front, but you can withdraw both contributions and investment earnings tax-free in retirement, as long as you meet certain criteria.
- Roth IRA Conversion: This is the process of moving funds from a traditional IRA into a Roth IRA. In doing so, you would pay income tax on the converted amount in the year of the conversion. The primary reason for doing this is the belief that your tax rate now is lower than it will be when you retire and start taking distributions.
There are many factors to consider when thinking about a Roth IRA conversion, such as current and future tax rates, the time until retirement, and your ability to pay the tax on the conversion with funds outside of the IRA. It's generally recommended to consult with a financial advisor before making this decision.
In the Individual Retirement Account (IRA) industry, a custodian refers to a financial institution that holds customers' securities for safekeeping to minimize the risk of their theft or loss. The custodian keeps the assets and the financial records in order and provides various administrative services. These services can include settling purchases and sales of securities, collecting dividends, distributing required minimum distributions, and reporting account activity to the IRS.
In the context of an IRA, the custodian could be a bank, credit union, brokerage, or other company approved by the Internal Revenue Service (IRS) to act as such. It's important to note that while custodians might provide ancillary services like investment advice or account management, their primary role is the safekeeping of the assets and compliance with IRS rules.
Custodians play a particularly crucial role when it comes to self-directed IRAs, where they hold a wider range of investment types (including real estate, private company stock, etc.) and assist with the unique regulatory requirements for those types of assets.
A Designated Beneficiary in the context of the Individual Retirement Account (IRA) industry refers to a person or entity that the account holder has chosen to receive the assets in their IRA upon their death. The IRA account holder can specify one or more beneficiaries, and these can include individuals, trusts, charities, or even the account holder's estate.
Designated beneficiaries play a crucial role in the distribution of the account's assets, as the selection can impact the tax implications and distribution options available to the beneficiaries. Properly naming a designated beneficiary is important to ensure a smooth transition of assets and to maximize the tax advantages associated with an IRA.
Direct Transfer refers to the movement of retirement funds from one financial institution to another without the individual owner taking control of the funds during the transaction.
This type of transfer can occur between similar accounts (like an IRA to another IRA) or different types of accounts (like an IRA to a 401(k)). Direct transfers are a tax-free method of moving retirement savings. This process is not subject to the once-per-year limitation that applies to 60-day rollovers, where the individual takes possession of the funds temporarily before reinvesting them in another retirement account.
It's important to ensure that the transfer is conducted properly as a "trustee-to-trustee transfer" where the two financial institutions directly transfer the money, rather than the individual taking temporary possession of the funds. Otherwise, it may be considered a distribution, which could lead to taxes and penalties.
Please note that there may be specific rules and regulations regarding the types of accounts that can be directly transferred, and it's always best to consult with a financial advisor or tax professional when making these kinds of decisions.
Early Distribution Penalty
An Early Distribution Penalty refers to the additional tax that may be charged on certain types of withdrawals from a tax-advantaged retirement account before the account owner reaches a certain age, typically 59 1/2 years old. This penalty is intended to discourage individuals from withdrawing their retirement savings too soon.
For example, if you withdraw money from an Individual Retirement Account (IRA) or a 401(k) plan before age 59 1/2, you may have to pay a 10% early withdrawal penalty in addition to regular income tax on the amount withdrawn. There are, however, certain exceptions to this rule, such as when the funds are used for qualified higher education expenses, certain medical expenses, or a first-time home purchase. It's always recommended to consult with a tax professional or financial advisor to understand the implications of an early distribution from a retirement account.
Individual Retirement Account (IRA)
An Individual Retirement Account (IRA) is a type of savings account that is designed to help individuals save for their retirement. IRAs are popular because they offer certain tax advantages that are not available with other types of savings accounts.
There are several types of IRAs, but the most common are traditional IRAs and Roth IRAs:
- Traditional IRA: With a traditional IRA, the money you contribute may be fully or partially deductible on your tax return, depending on your circumstances. The money in the account grows tax-deferred, meaning you don't pay taxes on your investment gains until you make withdrawals during retirement. When you withdraw the money at retirement, it will be taxed as regular income.
- Roth IRA: With a Roth IRA, contributions are made with after-tax dollars, meaning there's no immediate tax benefit. However, the big advantage of a Roth IRA is that the money grows tax-free, and you can make qualified withdrawals in retirement that are also tax-free.
Other types of IRAs include SEP IRAs (for self-employed people and small business owners) and SIMPLE IRAs (also for small businesses), among others.
The maximum amount you can contribute to their IRA is $6,000 per year, or $7,000 if you are age 50 or older. The actual amount may vary depending on your income, tax filing status, and other factors.
An Inherited IRA, also known as a Beneficiary IRA, is a type of Individual Retirement Account that is acquired by the non-spouse beneficiary of a deceased IRA owner. It allows the beneficiary to receive the assets of a deceased individual's IRA under a slightly different set of rules compared to the original IRA owner.
Upon the death of an IRA owner, the account's assets are passed onto the designated beneficiaries. If the beneficiary is not the spouse of the deceased, they can transfer the assets into an Inherited IRA.
With an Inherited IRA, the beneficiary must begin taking Required Minimum Distributions (RMDs), regardless of their age. The amount of the RMD is determined by the beneficiary's life expectancy and the account balance.
There are specific rules for how and when these distributions must occur. For example, beneficiaries used to have the option to "stretch" distributions over their lifetime, but with the passing of the SECURE Act in December 2019, most non-spouse beneficiaries are now required to deplete the inherited IRA within 10 years of the original owner's death.
This 10-year rule doesn't apply to all beneficiaries though. Exceptions include disabled individuals, individuals who are not more than ten years younger than the decedent, and minor children of the decedent (though once they reach the age of majority, the 10-year rule kicks in).
It's important to note that the rules for Inherited IRAs are complex and may have significant tax implications, so beneficiaries should seek professional advice to make sure they are in compliance with all regulations and to understand their options.
A Non-spouse Beneficiary in the context of the Individual Retirement Account (IRA) industry refers to an individual who inherits an IRA or other retirement account from the original account owner but is not the spouse of the deceased account owner. This could be a family member, friend, or any other person designated by the account owner as the beneficiary.
When a non-spouse beneficiary inherits an IRA, they must follow specific rules and guidelines set by the Internal Revenue Service (IRS) regarding required minimum distributions (RMDs), tax implications, and how the inherited assets can be managed. Non-spouse beneficiaries may choose to either liquidate the account within a specified time frame, typically five years or stretch the distributions over their own life expectancy, which may result in a reduced tax burden. These options and specific regulations may vary depending on the type of IRA (Traditional or Roth) and the age of the original account owner at the time of death.
A nondeductible contribution refers to a type of deposit made into an individual retirement account (IRA) for which the contributor doesn't receive a tax deduction in the year the contribution is made. Essentially, it means the money you put into your IRA has already been taxed.
This is in contrast to a traditional IRA, where contributions are typically made with pre-tax dollars, meaning the contributions can be deducted from your income, reducing your taxable income for the year and therefore your current tax liability.
Nondeductible contributions are often associated with a type of IRA known as a Roth IRA, which is funded with after-tax dollars. The advantage of making nondeductible contributions and paying taxes upfront is that withdrawals in retirement, including earnings, are typically tax-free, provided certain conditions are met.
However, nondeductible contributions can also be made to a traditional IRA, particularly in cases where a person's income exceeds the limits for deductible contributions. These contributions to a traditional IRA will not reduce current-year taxable income, but the investment earnings on those contributions will still grow tax-deferred until retirement. When withdrawals are made during retirement, the previously taxed contributions can usually be withdrawn tax-free, but the earnings will be subject to income tax.
It's important to keep track of nondeductible contributions to avoid double taxation when the money is withdrawn. IRS Form 8606 is used to keep a record of this.
Prohibited Transaction refers to certain types of transactions between the IRA and a disqualified person that are not allowed under the Internal Revenue Code (IRC).
According to IRC Section 4975, disqualified persons generally include the IRA owner, the owner's spouse, ancestors, lineal descendants, and any spouse of a lineal descendant. Other entities such as a corporation, partnership, trust, or estate in which the IRA owner has a 50 percent or greater interest could also be considered disqualified.
Prohibited transactions could involve, for example:
- Sale or exchange, or leasing, of any property between a plan and a disqualified person.
- Lending of money or other extension of credit between a plan and a disqualified person.
- Furnishing of goods, services, or facilities between a plan and a disqualified person.
- Transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan.
- An act by a disqualified person who is a fiduciary whereby he or she deals with the income or assets of a plan in his or her own interests or for his or her own account.
If a prohibited transaction occurs, the IRA loses its tax-exempt status and the entire value of the IRA becomes subject to income tax and possible penalties.
Qualified Charitable Distribution (QCD)
A Qualified Charitable Distribution (QCD) is a direct transfer of funds from your Individual Retirement Account (IRA), payable directly to a qualified charity, as described in the Internal Revenue Code. QCDs can be counted toward satisfying your required minimum distributions (RMDs) for the year, as long as certain rules are met.
Key points about QCDs:
- You must be 70½ or older to be eligible to make a QCD.
- QCDs are limited to the amount that would otherwise be taxed as ordinary income. This excludes non-deductible contributions.
- The maximum annual amount that can qualify for a QCD is $100,000. This applies to the sum of QCDs made to one or more charities in a calendar year.
- For a QCD to count towards your current year's RMD, the funds must come out of your IRA by your RMD deadline, generally December 31.
- The funds must be transferred directly from your IRA custodian to the eligible charity. If the IRA owner withdraws funds and then donates them, the transaction does not qualify as a QCD.
The major benefit of making a QCD is that the amount distributed is excluded from taxable income, which differs from regular withdrawals from an IRA, even if they are used to make charitable contributions. This can potentially reduce your taxable income and the tax rate imposed on other income.
The term "Qualified Distribution" is often used in the context of a Roth Individual Retirement Account (IRA) in the United States.
A Qualified Distribution from a Roth IRA is one that is tax-free and penalty-free. For a distribution to be considered "qualified," it must satisfy both of the following requirements:
- The distribution is made at least five years after the first contribution to any Roth IRA of the account holder. This five-year period begins on the first day of the tax year for which the contribution was made.
- The distribution is made:
- After the account holder reaches age 59.5,
- Because the account holder has become disabled,
- To a beneficiary or the estate of the account holder after the account holder's death, or
- For a first-time home purchase (up to a $10,000 lifetime limit).
Recharacterization in the context of Individual Retirement Accounts (IRAs) refers to the act of reversing or changing the type of a prior IRA contribution. In simpler terms, it's the process of converting a contribution from one type of IRA to another.
The most common recharacterization occurs between a Traditional IRA and a Roth IRA.
For example, if you made a contribution to a Roth IRA but later decide (within the allowed time period, usually by the tax filing deadline including extensions) that you would rather have made that contribution to a Traditional IRA, you can 'recharacterize' that contribution by transferring the contributed amount (plus or minus any associated earnings or losses) from the Roth IRA to a Traditional IRA.
The same process can be done in reverse, moving contributions from a Traditional IRA to a Roth IRA.
Recharacterizations can be advantageous if a person's tax situation changes and they decide that the tax benefits of one type of IRA are more suited to their needs than the other.
Note that this is distinct from a 'conversion' which is a process of moving money from a Traditional IRA to a Roth IRA, triggering a taxable event because Traditional IRA contributions are tax-deductible and Roth IRA contributions are made with after-tax dollars.
It's important to consult with a tax advisor or financial planner before making decisions about recharacterization to fully understand the tax implications and to ensure that all IRS rules and deadlines are adhered to.
Required Beginning Date (RBD)
The Required Beginning Date (RBD) is a term used in the Individual Retirement Account (IRA) industry in the United States. It refers to the date by which a holder of an IRA or a retirement plan must start taking required minimum distributions (RMDs) from their account.
In general, the RBD is April 1 of the calendar year following the calendar year in which the IRA owner reaches age 72, according to the SECURE Act of 2019. This applies to traditional IRAs, SEP IRAs, and SIMPLE IRAs, as well as most employer-sponsored retirement plans.
However, if the IRA owner continues to work beyond age 72 and does not own more than 5% of the company they work for, they may be able to delay RMDs from their current employer's retirement plan until they actually retire, a concept known as the "still working" exception.
Note that there are no required minimum distributions for Roth IRAs while the owner is alive.
Always consult with a financial advisor or tax professional for specific advice on retirement account distributions, as the rules can be complex and penalties for non-compliance can be substantial.
Required Minimum Distribution (RMD)
The Required Minimum Distribution (RMD) is the minimum amount that a retirement plan account owner must withdraw annually once they have reached a certain age. This age is typically 72 for most retirement plans, including traditional IRAs and 401(k) plans. This age could be different if there have been changes in regulations after my last training data.
The Internal Revenue Service (IRS) in the United States stipulates these rules to ensure that people don't just accumulate retirement account funds indefinitely, but actually begin to draw down these accounts in their retirement.
The amount that must be withdrawn is calculated based on the account balance at the end of the previous year and life expectancy tables provided by the IRS. If the RMDs are not taken, a penalty may apply, which is usually 50% of the amount not distributed as required.
Please note that the rules around RMDs can be complex and can change with new tax laws or regulations, so it's always a good idea to consult with a tax professional or financial advisor to understand the current requirements.
A Rollover Individual Retirement Account (IRA) is a type of retirement savings account that allows you to move funds from a previous employer-sponsored retirement plan, like a 401(k) or 403(b), into an IRA.
The primary purpose of a Rollover IRA is to maintain the tax-deferred status of the retirement assets. By moving the funds directly into a Rollover IRA, and not taking possession of the funds directly, you avoid immediate taxation and potential early withdrawal penalties.
The funds in a Rollover IRA can then be invested, often with a greater range of options compared to employer-sponsored plans. The types of investments available will depend on the financial institution that serves as the IRA custodian.
It's important to note that there are specific rules and timelines for conducting a rollover to avoid any potential tax consequences. It's always a good idea to consult with a tax or financial advisor when considering a rollover.
A Roth IRA (Individual Retirement Account) is a type of retirement savings account in the United States that offers certain tax advantages to encourage individuals to save for retirement. It was established by the Taxpayer Relief Act of 1997 and is named after its chief legislative sponsor, Senator William Roth.
Contributions to a Roth IRA are made with after-tax dollars, meaning that you've already paid income taxes on the money you're putting into the account. While there is no tax deduction for contributions made to a Roth IRA, the significant benefit comes from the fact that all earnings and withdrawals from the account, once you reach 59.5 years old and if the account has been held for at least five years, are generally tax-free.
This is different from a traditional IRA, where contributions may be tax-deductible (depending on your income and whether you or your spouse are covered by a retirement plan at work), but withdrawals in retirement are taxed as ordinary income.
Other notable features of a Roth IRA include:
- No Required Minimum Distributions (RMDs): Unlike traditional IRAs, which mandate that you begin taking distributions at a certain age (currently 72), Roth IRAs have no such requirement during the lifetime of the original owner. This allows for more flexibility in retirement planning and for wealth to be passed on to heirs.
- Income limits: Not everyone can contribute to a Roth IRA. The ability to contribute is phased out at higher income levels. The exact figures vary year by year and depend on your tax filing status.
- Contribution limits: The maximum annual contribution is subject to change, but as of 2021, the limit is $6,000 per year or $7,000 for individuals aged 50 and over.
It's also worth noting that Roth IRA contributions can be withdrawn at any time without penalty or taxes because they were made with after-tax money. However, this isn't the case for the earnings on those contributions—they are subject to taxes and penalties if withdrawn before age 59.5 and before you've held the account for five years.
Rule 72(t) is a provision in the United States Internal Revenue Code that allows for penalty-free withdrawals from an individual retirement account (IRA) before the age of 59.5. This rule applies to other tax-advantaged retirement accounts as well, such as 401(k)s and 403(b)s.
Normally, if an individual withdraws money from these types of accounts before reaching the age of 59.5, they would face a 10% early withdrawal penalty. However, Rule 72(t) provides a way to avoid this penalty if the individual can commit to taking substantially equal periodic payments (SEPPs).
These SEPPs must be calculated based on the life expectancy of the account owner and must continue for at least 5 years or until the account owner reaches age 59.5, whichever period is longer. The amount of these payments can be calculated using methods approved by the Internal Revenue Service (IRS).
It's important to note that while Rule 72(t) distributions can help avoid the 10% early withdrawal penalty, the distributions are still considered taxable income and will be subject to regular income taxes. Also, changing or stopping the payments before the end of the prescribed period can result in retroactive penalties.
As always, it's a good idea to consult with a financial advisor or tax professional before deciding to take 72(t) distributions, as it can have significant impacts on your retirement savings and tax situation.
A SEP-IRA (Simplified Employee Pension Individual Retirement Arrangement) is a type of retirement savings plan in the United States. It's designed to allow self-employed individuals and small-business owners to make tax-deductible contributions towards their own, and their employees', retirement savings.
SEP-IRA contributions are made by the employer only, and the employer can decide each year whether, and how much, to contribute. The contribution amount can vary from year to year, providing flexibility to businesses with fluctuating incomes.
Contributions to a SEP-IRA are made on a pre-tax basis, meaning they lower the taxable income of the participant for that year. The funds then grow tax-deferred until withdrawal. Distributions in retirement are taxed as ordinary income.
The maximum contribution limit was the lesser of 25% of the employee's compensation or $58,000 for the year, but these limits are subject to cost-of-living adjustments, so they may be higher now. Please check with a financial advisor or the IRS for the most current information.
The main advantages of SEP-IRAs are their simplicity to set up and administer, high contribution limits, and flexibility in annual contributions. However, unlike a 401(k), a SEP-IRA does not allow employees to make their own contributions.
Please note that tax laws can be complex and change over time, so it's always a good idea to consult with a tax or financial advisor for the most current and applicable information.
A SIMPLE IRA, or Savings Incentive Match Plan for Employees Individual Retirement Account, is a type of retirement account that is offered by many small businesses in the United States. It allows both employees and employers to contribute to a retirement savings account.
SIMPLE IRAs are generally easier to administer than other types of retirement plans, like 401(k)s or 403(b)s, which is why they're often chosen by small businesses. Under a SIMPLE IRA, an employer must either match employee contributions up to 3% of their compensation or make a fixed contribution of 2% of compensation for all eligible employees, even if these employees choose not to contribute themselves.
For employees, contributions are made pre-tax, meaning they lower the individual's taxable income. The money then grows tax-deferred until retirement, at which point withdrawals are taxed as ordinary income. The contribution limit for a SIMPLE IRA was $13,500 per year for employees under 50, with an additional $3,000 "catch-up" contribution allowed for those over 50.
Like other types of retirement accounts, there are penalties for withdrawing money before reaching the age of 59.5. Specifically for SIMPLE IRAs, withdrawals within the first two years of participation are subject to a 25% early withdrawal penalty, which is higher than the 10% penalty that applies to most other types of retirement accounts. After two years, the early withdrawal penalty drops to 10%.
It's important to note that tax laws and regulations can change, so for the most current information, it's best to check with a tax professional or the Internal Revenue Service (IRS).
A Spousal IRA is a type of Individual Retirement Account (IRA) that is designed for a married couple where one spouse earns income and the other does not. This allows the non-working or lower-earning spouse to contribute to an IRA, even without personal earned income, providing an opportunity to save for retirement.
There are two types of Spousal IRAs: Traditional and Roth.
- Traditional Spousal IRA: Contributions may be tax-deductible depending on your income and whether you or your spouse are covered by a retirement plan at work. Earnings can potentially grow tax-deferred until you need to take distributions, which are then taxed as ordinary income.
- Roth Spousal IRA: Contributions are made with after-tax dollars, meaning there's no upfront tax deduction. However, earnings and qualified withdrawals in retirement are generally tax-free.
The contribution limit is the same as for other IRAs: $6,000 per year, or $7,000 per year if you're age 50 or older. However, the actual amount you can contribute may be less, based on your income and tax filing status. Always check the current rules with the IRS or a financial advisor.
Remember, the working spouse must have enough earned income to cover both their own and the spousal IRA contributions. Also, you must be married and file a joint tax return to be eligible for a Spousal IRA.
A Stretch IRA is a wealth-transfer strategy that was used to extend the tax-deferred status of an Individual Retirement Account (IRA) by beneficiaries of these accounts. This strategy aimed to "stretch" the life—and thus the tax advantages—of an IRA by limiting the withdrawals to the required minimum distributions (RMDs) over the beneficiary's life expectancy.
Here's how it worked: when the owner of the IRA passed away, instead of the beneficiaries liquidating the account, they could instead base the RMDs on their own life expectancy. If the beneficiary was younger, this could significantly extend the tax-deferred growth of the IRA, as younger beneficiaries would have smaller RMDs, allowing more money to stay in the IRA and potentially grow over time.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 in the United States eliminated the Stretch IRA strategy for most non-spouse beneficiaries. Instead, non-spouse beneficiaries are typically required to distribute the entire inherited IRA within 10 years of the original account owner's death.
Please consult a financial advisor for the most up-to-date information, as rules can change and vary based on different circumstances.
Tax-deferred growth is a key concept in the retirement planning and investment industries, particularly when it comes to Individual Retirement Accounts (IRAs) and other types of retirement savings vehicles.
In the context of an IRA, tax-deferred growth refers to the way in which any earnings or gains within the account (such as interest, dividends, or capital gains) are not taxed at the time they are earned. Instead, the taxes on these earnings are deferred, or postponed, until the investor starts withdrawing money from the account, typically in retirement.
This allows the investor's money to grow faster than it would in a taxable account, because all of the money, including what would have been paid out in taxes each year, remains in the account to earn even more.
In a traditional IRA, distributions in retirement are taxed as ordinary income. In a Roth IRA, contributions are made with after-tax dollars, so qualified distributions in retirement are tax-free, offering tax-free growth as opposed to tax-deferred growth.
The benefit of tax-deferred growth is that many people will be in a lower tax bracket in retirement than during their working years, so they may pay less tax on the money when it's withdrawn compared to what they would have paid when it was earned. However, this may not be the case for everyone, and the tax situation can also depend on future changes in tax law.
A Traditional Individual Retirement Account (IRA) is a type of retirement savings account in the United States that offers tax advantages to encourage individuals to save for retirement. Here are some key features:
- Pre-Tax Contributions: Contributions to a Traditional IRA are typically made with pre-tax dollars. This means that the money you contribute can be deducted from your taxable income in the year you make the contribution, reducing your current tax bill.
- Tax-Deferred Growth: The funds in the account grow tax-deferred. This means that you do not pay taxes on the investment earnings and growth within the account until you start withdrawing the funds.
- Taxes Upon Withdrawal: When you start withdrawing the funds at retirement (you can start at age 59 ½ without penalty), the withdrawals are taxed as ordinary income.
- Required Minimum Distributions (RMDs): Once you reach age 72, you must begin taking required minimum distributions from your Traditional IRA, whether you need the money or not.
- Penalties for Early Withdrawal: If you withdraw money from your Traditional IRA before you reach age 59 ½, you typically will be subject to a 10% early withdrawal penalty in addition to regular income taxes, although there are some exceptions for specific circumstances like first-time home purchase, education expenses, or serious illness.
- Contribution Limits: The maximum you can contribute to a Traditional IRA in a year is $6,000, or $7,000 if you're age 50 or older. However, these limits are subject to periodic adjustments for inflation, so they may be different now.
- Income Limits for Tax Deduction: While anyone with earned income can contribute to a Traditional IRA, the ability to deduct those contributions on your taxes is phased out at higher income levels if you or your spouse also have a retirement plan at work.
Remember to always consult with a financial advisor or do your own research to stay updated with the most recent rules and regulations.
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