Traditional IRA

The IRA began back in 1974 when it was first added as a tax-advantaged investment (deferral of taxes until withdrawal). Current rules allow you to make annual tax-deductible contributions up to $5,500 (and an additional $1,000 if you are over age 50); these can be made before April 15, 2015 for calendar year 2014. There are certain restrictions for which taxpayers can take the deduction.

If you can participate in your employer plan and your income levels are higher than threshold amounts (single taxpayers with income in excess of $129,000 and married filing jointly with income in excess of $191,000), you may be limited in the amount of your deduction. An additional requirement is that you have earned income that equals or exceeds the amount of the contribution. Examples of earned income would be W-2 wages, sole-proprietorship income, or partnership pass-through income subject to self-employment taxes.

Advantages of an IRA

There are several advantages to having an IRA or some other tax-advantaged retirement plan:

• You are able to invest more dollars because the investment is on a pre-tax basis;

• The earnings are tax-deferred as well; and

• Taxes are paid only when you withdraw the funds down the road. The common thinking is that, at retirement, you should be in a lower tax bracket and, therefore, pay less in taxes. This thinking may need to be re-evaluated in the future based on where the tax law is heading.

Disadvantages of an IRA

It is only fair to consider the negative attributes as well as the good:

• If you should withdraw the funds before age 59 1/2, there could be a penalty for early withdrawal of funds; and

• You will pay at ordinary tax rates when the funds are withdrawn and possibly lose out on the preferred tax rates of capital gain and qualified dividends, which are taxed at lower rates.

Spousal IRA

As required by tax law, you must have earned income in order to contribute to an IRA. There is one exception to this rule. Should your spouse have earned income, you may treat a portion of his or her earnings as your earnings. This will allow a spouse to contribute to his or her own IRA separate from the working partner. This would be the same for traditional and same-sex marriages recognized by your home state.

Non-deductible IRA

If you are not eligible to take advantage of the tax-deductible IRA (for reasons mentioned above), you still can put money into your IRA. Keep in mind that one of the advantages is the tax deferral on the earnings held within an IRA even if you miss out on the tax deduction.

IRA Payouts

There are a number of considerations when planning for IRA withdrawals:

• If you make a withdrawal from an IRA before age 59 1/2, generally there will be a 10% penalty, in addition to the withdrawal being included as taxable income. There are a number of exceptions to this for hardship causes, but generally, it is not a good idea to withdraw funds until after this age;

• You may defer withdrawals until age 70 1/2. It is generally an advantage to defer the payment of tax as long as you can. This will allow for more funds (the funds you would have paid in taxes) to be invested longer; and

• Should one spouse pass away, you may elect to defer taking into income the IRA funds by completing a spousal rollover and deferring the income until a later date.

Roth IRA

In 1997, along came the Roth IRA. This IRA involves a different approach to investing one’s retirement funds.

The Roth does not allow for an income-tax deduction when you contribute funds. The benefit is that, under current tax law, you will not pay any income tax on the withdrawal of the funds, both income and contributions, provided that you do not withdraw within the first five years and you are older than age 59 1/2.

Best of all, you are not required to begin withdrawing funds during your lifetime if you so choose. As you consider these Roths, think estate planning.

Consideration of Roth Rollover

Beginning in 2010, any taxpayer may take funds out of an IRA account and roll them over into a Roth IRA. The disadvantage to this practice is that you must pay income taxes up front on funds being rolled over. However, the estate-planning opportunities are significant in the right situation.

Consider the following example. Grandparents roll their funds into a Roth IRA and pay the tax up front. They name their grandchildren as beneficiaries. This might allow the funds to continue to accumulate during the remainder of the grandparents’ life and then be drawn down over the following 20-plus years tax-free by the grandchildren. This is real planning, especially if you don’t need the funds during your lifetime.

Consult with a Professional

This topic is a very complex area of income tax and estate planning and is fraught with peril. Consider seeking a tax or estate professional to sit with you and review your situation, particularly because each situation is unique.

Kevin E. Hines, CPA, MST, CVA, CSEP, is a partner with Meyers Brothers Kalicka, P.C., with specialties in business valuations, estate planning, and taxes; (413) 536-8510.

As seen in the December 30, 2014 issue of Business West Magazine.