Written by:  John Paul Curtin

An Individual Retirement Account, or IRA, is an account that allows you to build retirement savings while taking advantage of tax-free growth on your investments. In 2019, the IRA contribution limit was raised to $6,000/year for individuals under 50, and $7,000/year for individuals over 50. The additional $1,000 for individuals over 50 is considered a “catch-up” contribution.

Depending on your income and tax filing status you may not be eligible to contribute to an IRA. For more information on eligibility and contribution limits, please visit this helpful webpage from Fidelity.

Common IRA Types

Traditional IRA – You make contributions to a traditional IRA with pre-taxed income, which in turn lowers your taxable income. And unlike a brokerage account where a capital gains tax must be paid for selling investments at a gain, IRAs are not taxed on capital gains or dividends. Instead, you are taxed on withdrawals from a traditional IRA, and they are treated as ordinary income at the time you make the withdrawals, regardless of any gains/losses on the investments.

Roth IRA – The other common type of individual retirement account is a Roth IRA. Contributions to a Roth IRA are taxed as ordinary income at the time the contribution is made. There is no immediate tax break for a Roth contribution, but when qualified withdrawals are taken, they are completely tax-free. Investments within the account can continue to grow without any capital gains or dividends being taxed, and upon withdrawal there is no ordinary income tax.

The $6,000 annual IRA contribution limit is across all types of IRA accounts. For example, if you contribute $4,000 to your traditional IRA, the most you can contribute to a Roth IRA is $2,000.

Qualified Withdrawals and RMDs

When an individual reaches the age of 59½, withdrawals from an IRA are considered “qualified.” Withdrawals taken prior to this age are included in gross income and are subject to an additional 10% tax penalty. There are some exceptions to this rule, such as qualified higher education expenses.

Between the ages of 59½ and 70½ individuals may withdraw as much or as little from their IRAs as they choose. It is important to remember that withdrawals from a traditional IRA are taxed as ordinary income.

Once an individual reaches 70½ there is a minimum withdrawal from IRA accounts that must be met each year, called a Required Minimum Distribution, or RMD. The RMD is calculated using your age and the year-end balance across your IRA accounts.

If you have any questions around optimizing use of Individual Retirement Accounts, please contact your Financial Strategist.  Not a client yet?  Get started here.