Yahoo Finance How to Maximize the Value of Your IRA
The rules for individual retirement accounts can be quite complex, especially as we begin drawing funds out of the accounts. But you shouldn't let the complexities get in the way of taking advantage of the many perks of IRAs. The benefits of saving in IRAs can be huge, and you should use the rules of IRAs to your advantage in order to wring every bit of value from the accounts. Here are several important ways to make the most of your IRA:
Start early. As with every other facet of financial planning, time is a major factor in favor of building up your savings. It is often recommended that parents begin encouraging their children to contribute to an IRA or Roth IRA as soon as the children begin earning money. Contributions are limited to the lesser of $5,500 ($6,500 if you are age 50 or older), or your earnings from wages for the year. So, if your teenager had a part-time job that paid her $2,231, her contribution to her Roth IRA for the year would be limited to $2,231.
Choose between a traditional IRA and a Roth IRA. If you are able to deduct an IRA contribution from your income and your marginal tax rate is in the higher brackets, contributing to a traditional IRA could significantly reduce your current tax bill. In many other cases it makes more sense to make your annual contributions to a Roth IRA. Here are three reasons for choosing a Roth IRA over a traditional IRA:
1. Roth IRA proceeds that are withdrawn after age 59 ½ are often tax-free. There is no tax on the earnings of the account or the withdrawals. You paid tax on the contributions when you earned them, so there is no additional tax on this money or the growth generated from the contributions.
2. There are no minimum distribution requirements for Roth IRAs. With a traditional IRA, you must begin withdrawing funds from the account after age 70 ½, whether you need them or not. Roth IRAs have no required minimum distributions for the original account owner.
3. Contributions to your Roth IRA may be withdrawn at any time, for any reason, with no tax or penalty. This rule only applies to contributions, not converted funds or investment earnings. Although an early withdrawal could work against your long-term goals, you have access to your contributions for emergencies without any onerous penalties.
Select the right beneficiary option. IRA owners can specify a beneficiary who will inherit the account when they pass away. Your heirs can effectively stretch out the benefits of your IRA for significant periods of time. Since taxes are not due on the account's holdings until they are withdrawn, in many cases your heirs can space out withdrawals for a long period of time in order to minimize taxes.
Many people choose their spouse as the primary beneficiary, with their children as secondary beneficiaries of the IRA. Your spouse will be able to treat your IRA as his or her own and use his or her own life expectancy to calculate required withdrawals from the account. If you choose instead to direct your IRA proceeds to your children, it often makes the most sense to ensure that each child is designated as the primary, sole beneficiary on a separate IRA. Otherwise, all of the children will be forced to take required minimum distributions over the lifetime of the oldest heir rather than their own lifetimes. In addition, make sure that your heirs understand the tax impact of inheriting an IRA. If they withdraw all the money at once they could trigger a huge tax bill.
Plan which investments to hold in your IRA. Given the tax-deferred nature of traditional IRAs and the tax-free potential of Roth IRAs, it makes sense to place specific types of investments in these accounts and hold other investments outside your retirement accounts. Income-generating assets, such as bonds or dividend-paying mutual funds, should be placed in tax-deferred accounts, so you can shift taxation to a later date. Appreciating assets, like most growth stock funds, should be placed in taxable accounts, since the capital gains taxes are typically lower than the regular income tax rate you pay on withdrawals from retirement accounts.
Jim Blankenship is a certified financial planner who blogs at Getting Your Financial Ducks in a Row.
Jim Blankenship is an independent, fee-only certified financial planner at Blankenship Financial Planning in New Berlin, Illinois. He is the author of "An IRA Owner's Manual" and "A Social Security Owner's Manual". His blog is Getting Your Financial Ducks in a Row, where he writes regularly about taxes, retirement savings and Social Security.
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