Index Card – IRA & Roth IRA
Investment is a lifestyle for those who enjoy the thrill of discovering values. IRA is a perfect platform to start such adventure. It is an account with simple requirements to open, flexibility in investment choices, and the tax incentives for faster growth. Simple as it is, however, there are many angles of IRA that are not commonly known.
Purpose:
It is a basic individual retirement savings accounts (IRA), administered by banks or other financial institutions, used by individual, self-employed or small business to provide simple long term retirement benefit.
Traditional IRA: Contribution is tax deductable; earnings in the account are not taxed when earned; both contribution and earnings are taxed upon withdrawals (possibly at lower tax rates) – tax deferred benefit. You can open such account before age 70-1/2, and after that age, you are required to take some money out (minimum distribution) every year (Note: minimum distribution is temporarily suspended in 2009)
Roth IRA: No tax deduction for contribution; earnings in the account are not taxed; withdrawals are tax-free. No age limitation to open such account. No required distribution. Excellent tool to build and pass down the wealth.
Investments:
Mostly through brokerage account to hold financial securities (stocks, bonds, mutual funds, ETF, etc); Direct real estate investment is not allowed, but it is ok to hold shares in REIT (real estate investment trust). Self-directed IRA can hold direct real estate investment if observing the proper IRS rules
Funding:
Annual contributions (or deduction in the case of Traditional IRA) are limited for both type of IRAs. The max in 2009 is $5,000 (or $6,000 if over age 50) per person. The max amount is reduced depending on your income level, filing status, and other 401(k) coverage.
You can fund your account as one payment or multiple payments through out the year until the tax filing due date (or April 15 of the following year)
Most retirement funds can be rolled into IRA and vise versa. If you leave a job with 401(k), you may roll the money into an IRA.
Saver’s Credit: Depending on income level, eligible people may get credits for their contrition to any retirement plans, including IRA.
Withdrawals:
Withdrawal before age 59-1/2, tax plus 10% penalty. Minimum annual distribution is required for owner after 70-1/2 age.
If taken out, you have 60-day period to deposit it back or to another IRA to avoid penalty and tax. You can do this only once a year.
Withdrawal Exceptions:
Early withdrawal are penalty-free if you use IRA money to pay higher-education expenses for people of your family
You may use up to $10,000 (with additional $10,000 for your spouse if qualified) to help purchase your first home. If you do not own a home for last 2 years, your purchase will be first home. Money has to be used for home purchase within 120 days. The $10,000 per person is a lifetime limit. When applied to Roth IRA, the account has to be older than 5 years to be free of penalty and tax. Otherwise, there will be no penalty but it is taxable.
You can also pay for medical expense when it exceeds the 7.5% of your adjusted gross income. You may pay for health insurance premiums if being unemployed for more than 12 months.
IRA vs. Roth IRA:
Traditional IRA gives you up-front jump start to build investment and tax you later. Roth IRA does not provide up-front tax help but gives you tax advantage all along.
The income limit for traditional IRA is lower than Roth IRA, so you may have non-deductable IRA contribution (its earning is still tax deferred). In this case, it is better to invest the non-deducible amount to a Roth IRA because of it is tax-free (better than tax-deferred).
Conversion
If expecting higher tax bracket at retirement time, it may be a good strategy to pay the tax now and convert to Roth IRA. You may qualify for conversion with AGI under $100,000, but this limit will expire in 2009. The decision to convert to Roth IRA needs many consideration. (Check this out for detailed)
Loans & Creditors
You can not borrow from IRA. IRA is not allowed to be used as loan security. IRA and Roth IRA (under $1 million) are under protection by the bankruptcy law. Many state has laws to protect IRA assets from creditors.
It is known that people take advantage of the 60-day rollover period to take out a “short-term loan” from IRA (Check the explanation here). Be warned that you have to have fund to cover it within the strict 60-day period. Plus this is only available once a year.
Divorce:
IRA can be transferred completely to another spouse by change of name of the holder. If divorce agreement calls for a split, partial value of IRA can be transferred by the bank to an IRA under another spouse’s name. It is a tax-free transfer.
Inheritance:
If from deceased spouse, can take over the IRA as owner. If from non-spouse, need to transfer it to your own IRA (trustee-to-trustee, or by the bank). Still subject to the same withdrawal rules.
Other accounts build on IRA:
SEP IRA: A traditional IRA funded by employer but set up in employee’s name; used by small business or self-employed as retirement funds. It has very high max contribution limit, $49,000 in 2009.
Simple IRA: A simplified pension funded for employee with matched employer contribution, similar to the corporation 401(k) plan. Max contribution is $11,500, $14,000 if older than 50, in 2009. (Note: for corporate 403(k), the max is $16,500, $22,000 if older than 50, in 2009)
Self-directed IRA: A plan allows account holder to make direct investment decisions, including real estate, but subject to more IRS rules.
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