IRA's & Retirement
What you need to know.
IRA's: Contribution limits, Rollover Options, and Withdrawals for your Traditional, Rollover, Roth, SEP, and SIMPLE IRA retirement account.
IRA's are one of the most popular and widely used retirement accounts by American's today. Chances are you have an IRA, it could be a rollover IRA from and old 401(k) or a Roth IRA that you started on your own. Although they are a popular tool, and can be a very important part of your retirement plan, it is equally important to understand how they work, what the contribution limits are, how much you can deduct, and the types of withdrawals you can take.
Knowing the IRA rules & limits will make you more informed, thus empowering you to make better decisions when it comes to your retirement planning and how IRA's fit in the bigger picture. I will outline the following about IRA's below:
- What is an IRA
- Types of IRA's, and who is allowed to establish them
- IRA Contribution Limits
- IRA Deduction Limits
- IRA Rollover Rules
- IRA withdrawals, when you can take them and how they are taxed
- Investment options for, and places you can set up IRA's
What is an IRA?
An IRA is a Individual Retirement Account, described as a Individual Retirement Arrangement in the IRS Publication 590. It is an account that you are permitted to set up where you can save and invest your money for the future. The type of IRA you use and how much you invest in it is a matter of personal planning and should be customized based upon your current financial situation and when you want to retire.
Types of IRA's, and who is allowed to establish & contribute to them
The two most commonly used IRA's are Traditional (Rollover) IRA's and Roth IRA's. There are also SEP and SIMPLE IRA's, and the less well known Self-Directed IRA. Here is how they are each treated for tax purposes and who is allowed to contribute to them.
Is an IRA that allows you to save for retirement while giving you tax advantages now and in the future. It was first available for use in 1974. Any money you save (contribute) to a traditional IRA is allowed to be deducted, within the IRS limits, for the calendar year you contribute the money. The money then grows tax deferred until you take it out in the future.
For example, you put in $100 a month into a traditional IRA, that would be $1,200 for the year. If you were within the IRS deduction limits, you would be allowed to deduct some or all of this contribution on your taxes for the same year. So, if you made $50,000 for 2017, put $1,200 into a traditional IRA, your taxable income would be $48,800 (assuming you have no other deductions). This is an overly simplified example, but it does illustrate how it can work.
Is an IRA that works very much the same way as a traditional IRA, but any contributions you make are after tax, in other words you do not get a tax deduction for them now. Your money grows tax deferred, just like the traditional IRA, and when you take distributions in the future they are all tax free! (assuming you followed all the IRS rules)
A rollover IRA is just that, a rollover. When you take an old retirement account (could be an IRA, 401(k), 403(b), etc.) and roll it over to a new or existing IRA account it is referred to as a rollover IRA. There are particular rules for rollovers, which I have previously written about here, so make sure you follow the IRS guidelines on rollovers as there can be penalties and taxes for doing it incorrectly.
A SEP (Simplified Employee Pension) is an IRA that is typically set up by self-employed individuals or small business owners to help contribute to employees and the owners retirement. A SEP IRA is treated like a traditional IRA for investment, rollover, and withdrawals, but does have some specific rules around contributions. Only the employer contributes to the IRA's, employees do not, but they are vested 100% right away.
A SIMPLE (Savings Incentive Match Plan for Employees) is an IRA that allows employees and employers to contribute to traditional IRA's set up through a startup or small business. The employer set's the plan up and allows, with some possible restrictions, employees to sign up for and contribute to their own IRA.
IRA Contribution Limits (2017)
The amount you contribute to an IRA is subject to certain limits that the IRS has put in place. Here are the limits for the different IRA's in 2017:
- Traditional & Roth IRA 2017 Contribution Limit: $5,500. For those over 50 years old there is a Catch Up contribution allowed of an additional $1,000. These limits do not apply to Rollover contributions.
- SEP IRA 2017 Contribution Limit: An employers contribution to an employees SEP IRA cannot exceed the lesser of 25% of the employees compensation or $54,000.
- SIMPLE IRA 2017 Contribution Limit: An employee may not contribute more than $12,500 for 2017. For those over age 50, there is a $3,000 Catch Up contribution.
Keep in mind that there are a lot of nuances with IRA's. Make sure to check out the IRS details here and to speak with qualified professionals who have experience with IRA's.
Roth IRA's contributions are not able to be deducted, so no worries with this one!
For Traditional IRA's there are specific rules for being able to deduct your contributions.
- If you, or your spouse if you are married, are covered by a retirement plan at work then your deduction may be limited depending on your income.
- If you, and your spouse, are not covered by a retirement plan at work you are allowed a full deduction.
Fer SEP IRA's, the employers contribution into an employees IRA account is fully deductible to the business owner.
For SIMPLE IRA's the employee receives a full deduction for their contribution, and the employer receives a deduction for any match they contribute on behalf of the employee.
Why would you want to rollover your IRA? There are many reasons including things like; wanting to change the adviser you are using to help manage your money, new or different investment options, or simply to consolidate numerous IRA's into one account. IRA rollovers are non-taxable transfers so you don't need to worry about any tax liabilities to do a rollover. Keep in mind that you will receive a 1099R the January following the year you did your rollover. This is simply for reporting purposes to the IRS and does not mean you are going to pay taxes.
You are allowed to rollover your IRA as long as you follow the IRS guidelines. See my previous post here for which accounts can be rolled over and where they can be rolled over to. There are three ways to complete a rollover:
- Direct rollover. When getting a distribution from a retirement plan, like a 401k, you can request that the rollover check be made out to your new IRA or retirement plan.
- Trustee-to-trustee transfer. Similar to a direct rollover, when transferring one IRA to another you can request the rollover check be made out directly to the new IRA.
- 60-day rollover. If you have a rollover made out directly to you, you will have 60 days to redeposit it into a new IRA. Taxes will be withheld in this case, so you would need to make up this difference with other funds you may have.
Can you take money out of your traditional IRA, SEP or SIMPLE IRA while you are still working?
You sure can, and you don't even need to document any type of hardship, but anything you take out of the IRA will be included in your gross income for the year, and it may be subject to an additional 10% tax (penalty) if you are under the age of 59 1/2. If you are taking money out of a SIMPLE IRA in the fist two years since you started putting money in it, your withdrawal would be subject to an additional 25% tax (penalty).
There are some exceptions to having to pay these additional taxes (penalties), which are specific to your circumstance, like taking out a one time distribution to help pay for your first house, which is limited to $10,000. Check out this IRS chart for all the exceptions.
What is a Required Minimum Distribution (RMD)?
When you turn age 70 1/2 the IRS requires you to start taking distributions from your IRA's (except Roth IRA's). How much you are required to take is calculated by dividing the end of the previous years account balance by the IRS table life expectancy amount. Here is a link to the IRS page that has worksheets on how to calculate your RMD amount and when you must start taking it. Whatever you take out of your IRA is fully taxable to you as income for that year. You can ask your IRA provided to have federal and state taxes withheld from your distribution, or you can take the full amount knowing you will need to account for it when you do your taxes for the year.
Can you take a Qualified Charitable Distribution?
Yes, you sure can, and it will even satisfy your RMD! The IRS requires the amount going to a qualified charity be sent directly from your IRA to the charity to be excluded from your taxable income.
Roth IRA Distributions
Since you never took a deduction on the contributions you made to your Roth IRA, you are not required to pay taxes on any distributions you take from it. The Roth IRA is also not subject to the RMD rules. However if you inherited a Roth IRA you will be required to start taking money out of it, but it is still not taxable to you.
What type of investments are available for your IRA, and where can you set one up?
There is no approved list of investments for IRA retirement plans. However there are special rules contained in the Employee Retirement Income Security Act of 1974 (ERISA) that apply to plan investments. These rules can be rather technical, I encourage to see them here on the IRS website if you wish to learn more about them.
Here is a list of the more common investments I have seen people use in their IRA's:
- Mutual Funds
- Exchange Traded Funds (ETF's)
- Money Markets
- Separate & Managed Accounts
- A variety of fixed, indexed, variable, and income annuities
- Startup business stock (ROBS IRA)
- Real Estate Investment Trusts (REIT's)
There are some additional holdings one may use if they are using a self-directed IRA, but this is less common.
Where can you set up an IRA?
Luckily you can set up an IRA at almost any financial institution, in person or online. It has been my experience that most people tend to favor setting up and managing and IRA with the help of an experience professional like a financial adviser. Here is a list of the more common places to set up an IRA:
- Bank or Credit Union
- Brokerage company (online or brick & mortar)
- Life Insurance company
- Investment bank
- Registered Investment Advisor (RIA)
So why is an IRA important for my retirement?
The person you are today is the person who is saving for who you will be 10, 20, or 30 years from now. An IRA is simply a tool for you to be able to save money for retirement, for the person who you will eventually become.
Don't you want to take care of this person? The IRA is a widely used and well know tool that can give you a lot of flexibility in who and what you invest in, how much you choose to invest, and how you are taxed. If you have access to a retirement plan through your employer, certainly consider it, but keep in mind you can always take that money in the future and roll it over to an IRA when you changes jobs or retire. Having control over your money is very important, and IRA gives you a lot of control.
I hope this information has been helpful. Although it is not exhaustive of all the nuances IRA's have, it should give you a great start in figuring out which IRA makes the most sense for you and your money.
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