People often wonder what type of IRA best suits their needs. The answer depends on a person’s short and long term goals, and on their individual and family circumstances. IRA stands for Individual Retirement Account
, and as the name suggests, it is an investment vehicle designed to ensure income during retirement. They were first introduced in 1974, with the passage of the Employee Retirement Income Security Act
(“ERISA”). 26 U.S.C. § 7701(a)(37). Since the introduction of IRAs, Congress has acted to increase the contribution allowed.
Although there are several types of IRAs, the two most popular are Traditional IRAs and Roth IRAs. Both types of IRAs have their benefits and limitations, but they can be invaluable tools if used properly. Contributions to Traditional IRAs are tax deductible, subject to annual contribution limits. Contributions to Traditional IRAs can result in significant tax benefits, especially for people in higher income tax brackets. Additionally, transactions within the IRA are also protected from taxation. Withdrawals are generally subject to income tax, but there is presumption that the contributor will be at lower tax bracket during retirement.
Conversely, contributions to Roth IRAs
do not provide the ability to deduct contributions from income. However, withdrawals are exempt from income tax, which means that any appreciation in value between the time of contribution and time of withdrawal will be tax exempt.
Both of these instruments have limitations on the amount one can contribute and when distributions are possible. Although one may contribute as much money as one wants to either type of IRA, there are specific rules that govern how much one can contribute tax free. Distributions can happen at any time, but unless certain conditions are met, distributions before the age of 59 ½ could result in significant tax and early withdrawal penalties. Because the rules governing the taxation of contributions and distributions from IRAs are very complex, it is important to obtain assistance from a tax advisor or estate planning attorney.
While IRAs are important retirement planning tools, the rules governing them are complex and an experienced estate planning attorney should assist with reviewing these strategies in conjunction with the overall estate plan. At the Law Office of Cynthia Hayes Hutchins, P.C.
, we have over 25 years of experience estate planning, and we are ready to answer any questions that you may have.
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