Individual Retirement Accounts (IRAs)

Individual Retirement Accounts (IRAs) function as personal tax-qualified retirement savings plans. They are easy to set up and to maintain. Plus, the are extremely flexible. Their are two major types of Individual Retirement Accounts—traditional and Roth—and we will cover the highlights of each type.

IRAs are set up as trusts or custodial accounts for the exclusive benefit of an individual and his or her beneficiaries. You can set up an IRA simply by choosing a bank, mutual fund, brokerage house or other financial institution to act as trustee or custodian. The institution will give you the necessary forms to complete. A lesser-known alternative is to purchase an individual retirement annuity contract from a life insurance company. An individual cannot be his own trustee.

Which type of IRA is the right choice for you? While that depends upon many factors, but this table (modified from IRS Publication 590,Individual Retirement Arrangements (IRAs)) highlights some of the key differences.

Question	Answer
	Traditional IRA	Roth IRA
Is there an upper-age limit on opening an IRA?	You must not have reached age 70½ by the end of the year you open a traditional IRA.	There is no upper age limit on opening a Roth IRA.
Am I required to start taking distributions when I reach a certain age?	Yes. You have to start taking minimum distributions by April 1 of the year following the year you reach age 70½.	No. If you are the original owner of a Roth IRA, you never have to start taking distributions. There are no minimum distribution requirements, regardless of your age.
What is the maximum amount that I can contribute to my account in 2013?	For 2013, the maximum you can contribute to a traditional IRA is the lesser of: $5,500 ($6,500 if you will be 50 or older by the end of 2013,) or your taxable compensation for the year. There is no upper limit on how much you can earn and still contribute.	For 2013, the maximum you can contribute to a Roth IRA is the lesser of: $5,500 ($6,500 if you will be 50 or older by the end of 2013,)or your taxable compensation for the year. However, the amount you can contribute may be reduced based upon your income, filing status, and if you contribute to another IRA.
Are my contributions deductible?	Maybe—depending upon your income, filing status, whether you (or your spouse) are covered by a retirement plan at work, and whether you receive social security benefits.	No. You can never deduct contributions to a Roth IRA.
Do I have to pay taxes on distributions from my account?	Distributions from a traditional IRA are taxed as ordinary income. However, if any of the contributions were non-deductible, then a portion of the distribution will not be taxable.	Distributions from a Roth IRA (both what you contributions and earning on that money) generally are not taxed.

Traditional IRAs

Who can set up an IRA? Anyone who works, whether as an employee or self-employed, can establish an Individual Retirement account.

How much can I contribute? The most that you can contribute to an IRA in 2013 is the smaller of $5,500 or an amount equal to the compensation includible in income for the year. You don't have to contribute the full amount allowed every year. You may skip a year or even several years. You may resume making contributions in a later year, but you cannot "catch up" for years no contribution was made.

The contribution limit is based on your compensation, not your income. This means that the limit is based on your wages, salaries, commissions and other sources of earned income. It does not include deferred compensation, retirement payments or portfolio income such as interest or dividends.

Those 50 years old and above will also be allowed to make additional $1,000 catch-up contributions to an IRA each year to help them save more for retirement.

The same dollar limit applies even if you have more than one IRA, or more than one type of IRA.

When both a husband and wife have compensation, the limit applies separately to each, so that as much as $11,000 can be contributed in 2013 (13,000 if both are 50 or over). Also, up to $5,500 may be contributed to an IRA on behalf of a nonworking spouse in 2013 ($6,500 if the nonworking spouse is age 50 or over). Separate accounts must be used for each spouse. The couple must file a joint tax return to claim the deduction, and the combined compensation of both spouses must be at least equal to the amount contributed to both spouses' IRAs.

When can I open an IRA account? In addition to being a helpful retirement planning vehicle, the IRA can help offset income tax liability while you are still working. Because you can claim an IRA contribution deduction on your tax return, even if IRA was established and a contribution made after year-end, it can serve as a "last-minute" tax savings strategy. However, the contribution must be made no later than the due date for filing the income tax return for that year, not including extensions. This generally means that you have until April 15th of the following year to make the contribution and deduct it on your tax return.

You can not open a traditional IRA during the year in which you turn 70.5 years old. If you are interested in establishing an IRA and you are age 70 or older, you must consider a Roth IRA

Nondeductible contributions. You can make a nondeductible contribution to an IRA, even if your income is to high to claim a deduction for that amount. However, your total annual contributions to any type of retirement IRA, both traditional and Roth, may not exceed $5,500 in 2013 ($6,500 if you are at least age 50). Just be sure that you don't mix deductible and nondeductible contributions (or Roth IRAs, or converted Roth IRAs) in the same account. The earnings on nondeductible contributions will still accumulate on a tax-deferred basis, and when you make withdrawals from your account, you'll be able to receive your original contributions (but not the additional buildup in value over the years) tax-free. To report nondeductible contributions, you must file Form 8606 with your tax return.

What happens if I contribute too much during the year? If you contribute more than the allowable amount, a six percent excise tax penalty will be assessed. This penalty is due for the year of the excess contribution and for each year thereafter until corrected. In addition, no contributions may be made to an inherited IRA in a form other than cash, or during or after the year in which the individual reaches age 70.5.

When can I take withdrawals/distributions from my IRA. There are rules limiting the withdrawal and use of your IRA assets. Violation of the rules generally results in taxation of the withdrawn amount, plus a penalty equal to 10 percent of the withdrawal. Generally, you violate the rules if you withdraw assets from your IRA before you reach the age of 59.5. However, there are special exceptions that allow you to take distributions from a traditional (non-Roth) IRA if the amounts are used to pay medical expenses in excess of 10 percent of adjusted gross income (7.5 percent if age 65 or over, for tax years beginning after December 31, 2012) or if the distributions are used by certain unemployed, formerly unemployed, or self-employed individuals to pay health insurance premiums. You can take a penalty-free withdrawal from any type of IRA to purchase your first home.

For IRAs that are not Roth IRAs, you can also take penalty-free withdrawals before age 59.5 to pay certain education expenses for yourself or your dependents, or if you set up a schedule to take "substantially equal" periodic payments for the rest of your life.

Do I have to take distributions from my traditional IRA? You cannot keep funds in a traditional IRA indefinitely: it is designed to be a "retirement" account, not an estate planning tool. The amount that must be distributed each year is referred to as the required minimum distribution (RMD.)

Think Ahead: Even if you starting making withdrawals from your account before you reached age 70.5, you must calculate the RMD and make sure that you receive at least that much annually.

If there are no distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required.

You generally must start receiving distributions from your IRA by April 1 of the year following the year in which you reach age 70.5. This is referred to as the required beginning date. Once you reach the age where you must take a RMD, you must continue to take that withdrawal by December 31 of each succeeding year.

Can I deduct my contributions? Everyone is eligible to establish and maintain an IRA, but whether the contributions into the IRA will be deductible depends on the individual's (or, if married, the couple's) income level and whether or not the individual (and/or the spouse) is covered by another pension plan at work.

If neither the individual nor spouse is covered under another retirement plan, they may take full advantage of the tax deduction for the amount contributed, regardless of their income level.

If the individual making the contribution is covered under another retirement plan, the amount of the contribution eligible for deduction is determined by the filing status and adjusted gross income of the couple, as shown on the Form 1040 Income Tax Return. The following IRS-provided table is in effect for 2013.

If Your Filing Status Is...	And Your Modified AGI Is...	Then You Can Take...
single or head of household	$59,000 or less	a full deduction up to the amount of your contribution limit.
	more than $59,000 but less than $69,000	a partial deduction.
	$69,000 or more	no deduction.
married filing jointly or qualifying widow(er)	$95,000 or less	a full deduction up to the amount of your contribution limit.
	more than $95,000 but less than $115,000	a partial deduction.
	$115,000 or more	no deduction.
married filing separately	less than $10,000	a partial deduction.
	$10,000 or more	no deduction.
If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined under the "Single" filing status.

If the individual making the contribution is not covered by another retirement plan at work, but his or her spouse is covered by such a plan, the non-covered individual may make deductible contributions to an IRA, but the deductibility of the contributions is still phased-out if joint income is too high. The deductibility of contributions phases-out at income levels ranging from $178,000 to $188,000 for joint filers in 2013.

These dollar amounts have been adjusted for inflation through the past several years, and will continue to be adjusted in the future.

Roth IRAs

Roth IRAs differ from traditional IRAs in several ways, but the most significant of these is that all distributions from a Roth IRA, including all the build-up in value over the years, are tax-free if certain conditions are met. Bear in mind, that the contributions to a Roth IRA are never deductible from income as can be the case with a traditional IRA: all contributions are made with "after-tax" dollars.

Distributions from a Roth IRA will be tax-free if the following two conditions are met:

• The distributions must be made five years or more after the account was opened, and
• The distributions must commence after you attain age 59.5 or have become disabled.

While tax-free income is great, there are other significant benefits to a Roth IRA as well.

• There are no required minimum distributions, regardless of your age. This makes the Roth IRA useful for both retirement planning and estate planning, since you can leave all the funds in the account for as long as you wish and pass any remainder on to your heirs.
• There is no age at which you must stop making contributions. Again, this goes to the dual aspect of a Roth IRA--retirement and estate planning.

However, there is one significant limitation—higher income taxpayers are limited in the amount they can contribute to a Roth IRA. Joint filers with income under $178,000 in 2013 can make full contributions to Roth IRAs. For those with income between $178,000 and $188,000 in 2013, the contribution amount is phased down, until it is phased out completely at $188,000 in 2013. For singles, the phase-out range is between $112,000 and $127,000 in 2013. These amounts are adjusted for inflation annually.

Can I convert my traditional IRA to a Roth IRA? You can convert a "regular" IRA to a Roth IRA. The catch is that you must pay income tax for the year of conversion on the entire amount that you convert. Plus, the converted amount must remain in the account for five years. If it is withdrawn prematurely a 10 percent penalty will apply and any tax due on the conversion that has not already been paid will become due in the year of the withdrawal.

Prior to 2010, higher-income taxpayers were barred from converting a traditional IRA to a Roth IRA. However, starting in 2010, this $100,000 adjusted gross income ceiling was eliminated. Thus, anyone with a regular IRA can convert it to a Roth IRA. A conversion is treated as a taxable distribution, but is not subject to the 10-percent early withdrawal penalty.

Recent tax changes make an important change for 401(k) and some similar plans. The changes loosen the restrictions for moving funds to a designated Roth account in the same plan. This may prove to be very beneficial to participants in 401(k) plans with in-plan Roth conversion features.

Should you convert to a Roth IRA? The Roth conversion decision is not clear cut because there can be significant advantages, as well as significant risks. There are a number of factor to consider to help evaluate whether a Roth conversion is a brilliant financial move or costly blunder. Bear in mind that you will need to work with a financial professional In order to maximize your benefit and minimize the cost should your initial analysis point toward conversion.

The three most significant factors to consider are:

1. What will your present and future tax liability be;
2. How will you pay the increased tax liability the results from the conversion income, and
3. When will you need to use the money in the account.

Another critical factor, and one that is often overlooked in Roth advice columns, is state tax law, which may or may not follow the federal rules. Less important factors, but certainly worth mentioning, are the nature of the contributions to the traditional IRA, any upcoming education expenses you will incur and the impact on social security and Medicare B.

What is your tax bracket going to be in the future? If you are planning to retire in the near future and expect to see your tax rate decline as a result, avoiding tax on the conversion may be wiser than attempting to avoid tax on the distributions in the future. However, its probable that income tax rates will be at their lowest for many years--therefore, you may want to pay your tax bill now. Remember, state taxes figure into your overall tax picture and its likely that they will also increase in the future. This is where a professional can help you decide by crunching the numbers for a variety of scenarios.

State taxes vary widely. If you thinking of relocating in another state, then make sure to have your accountant take that into effect when comparing the tax liability for the various scenarios.

How are you going to pay that tax bill?

If the amount converted was largely from earnings and/or deductible contributions, then you may have a significant tax bill. If you need to dip into your tax-deferred savings to pay the tax bill, you should be very hesitant to convert funds. If you are younger than age 59.5 and, as a result, will incur the 10 percent excise penalty on early withdrawals, you should be very, very hesitant. Note: for conversions made in 2010, you could elect to split the taxes due and pay tax on one-half of the conversion in 2011 and tax on the other half of the conversion in 2012. This was only allowed for conversions that occurred in 2010.

You don't have to convert the entire amount in your traditional IRA in one transaction. Therefore, it is possible to work out a conversion schedule that will prevent a large tax bill.

When are you going to need that money?

If you are going to need to draw upon those funds sooner rather than later, conversion might not pay off. First, you may not have enough tax-free appreciate to offset the tax hit you took on conversion. Second, even you are over 59.5 when you withdraw funds, you may be liable for penalties earnings must stay in the Roth for five years. From this angle, the ideal candidate for a Roth conversion is a taxpayer who is in a relatively low income tax bracket now and who is able to let the money accumulate for many years.

Where do you pay state taxes?

Nearly all of the information out there about Roth IRA conversions focuses on the changes in federal tax rules. However, nearly everyone also has a state tax bill to worry about. And, not all states will follow the federal rules--whether by design or inertia. Overlooking state tax consequences can derail an otherwise sound investment decision. Make sure your financial planner knows the state laws that affect you.

Did you make a significant amount of non-deductible contributions to your traditional IRA?

The larger the amount of non-deductible contributions, the more attractive a Roth conversion can be. The roll-over from the nondeductible contributions is tax-free. Once the principle is in a Roth IRA, the earnings in the Roth IRA will accumulate tax-free, where they would be taxed on distribution from a traditional IRA.

This math can get complicated rather quickly and needs to be handled by a professional.

While the items discussed above are the major factors that play into a decision to convert several others should be noted:

• Are you on Medicare or Social Security? If so, watch out. the amount of income that must be included upon conversion can mean that your social security benefits will be taxable...up to 85%. And, because Medicare Part B premiums are based on income, that conversion could move you into a higher premium bracket for the coming year.
• Are you counting on financial aid for college? If you, or a dependent, is hoping for financial aid, the large income spike could mean that the amount of aid would be reduced, or even eliminated. Many schools will consider extenuating circumstances. Before making a decision, it's wise to call the financial aid department of the college or university to find out what their policy is.
• Do you want to avoid "required minimum distributions" for years after the conversion year? While you must begin taking required minimum distributions from a traditional IRA or from a 401(k) when you reach age 70 1/2, you don't need to take RMDs from a Roth account.

When can I take withdrawals/distributions from my Roth IRA. There are fewer options for penalty-free early withdrawals of funds from a Roth IRA than from a traditional IRA. First, there is the five-year waiting period for withdrawals. This means that you cannot withdraw funds from your Roth IRA until after a five-year period that starts with the first tax year for which a contribution was made to your Roth IRA. Second, you must be at least 59.5 years old at the time of the initial withdrawal. The only other exception for a Roth IRA is that you can take a penalty-free withdrawal from any type of IRA to purchase your first home.

Transfers and Rollovers

The shifting of funds from one IRA trustee/custodian directly to another trustee/custodian is called a transfer. It is not considered a rollover because nothing was paid over to you. A transfer is tax-free and there are no waiting periods between transfers.

A rollover, in contrast, is a tax-free distribution to you of assets from one retirement plan that you then contribute to a different retirement plan. Under certain circumstances, you may either roll over assets withdrawn from one IRA into another, or roll over a distribution from a qualified retirement plan into an IRA. If the distribution from a qualified plan is made directly to you, the payer must withhold 20 percent of it for taxes. You can avoid the withholding by having the payer transfer the funds directly to the trustee/custodian of your IRA.

A rollover must be made within 60 days of receipt of the distribution. You cannot deduct the rollover contribution, but you must report it on your tax return. Rollovers not completed within 60 days are treated as taxable distributions. On top of the regular income tax, you may also have to pay a 10 percent excise tax penalty on the premature distribution and another 15 percent excise tax penalty on an excess distribution.

A rollover from one IRA to another enables you to change your investment strategy and enhance your rate of return. This type of rollover may be made only once a year. This rule applies separately to each IRA owned. If property other than cash is received, that same property must be rolled over. Except for an IRA received by a surviving spouse, an inherited IRA cannot be rolled over into, or receive a rollover from, another IRA.