One of the most important features of your individual retirement account (IRA) is the fact that it is an "individual" account. You can customize your deposits and take withdrawals when you want to, and you are responsible for paying taxes on distributions. You can even control what happens to it after you die. Want to take advantage of all that your IRA has to offer? Read on for some little-known features that will help you get the most out of your contributions.
It is possible to end up with more than one IRA for a number of reasons. Here are examples:
Contribute to as many IRAs as you want, but the total deposited in all IRAs is limited to the annual maximum amount. The annual maximum contribution for 2017 is $5,500 (or $6,500 if you are age 50 or older). So, if Bob, age 42, deposits $2,000 into his traditional IRA, he can contribute no more than $3,500 to his Roth account during the same year. (For more insight, read IRA Contributions: Eligibility and Deadlines.)
When making your regular contribution to your IRA for the year, it must be done in cash. This limitation does not apply to the distribution of securities that are rolled over, as these must generally be rolled over in kind.
One of the main advantages of an IRA account is the ability to defer taxes on gains and investment income. You can't use losses inside the IRA to offset gains, but if you distribute the total balance from your traditional IRAs and the amount is less than your basis in the account, you can deduct that loss. (For related reading, see Deducting Losses on Your IRA Investments.)
More specifically, the IRS allows you to deduct losses on a traditional IRA with the following caveats:
"The same rule applies for Roth IRAs," says Curt Sheldon, CFP®, EA, AIF®, president and lead planner, C.L. Sheldon & Company, LLC, Alexandria, Va. "Once all Roth IRAs are emptied (all funds distributed) you can deduct losses up to the amount of your contributions (basis)."
Traditional IRA owners must begin taking required minimum distributions (RMDs) by April 1 of the year after they turn 70½ years old. The minimum amount distributed is based on the balance of the account on December 31 of the previous year and the owner's life expectancy. For each year thereafter, the RMD must be withdrawn. (To learn more, see An Overview of Retirement Plan RMDs.)
If you have multiple traditional IRAs, you don't have to take RMDs from all of them. You can combine the total RMD amounts for each of your IRAs, and take the total from one IRA or a combination of IRAs. For example, you may prefer to liquidate the investments in one IRA over the investments in another. (For more on RMDs, see Avoiding Mistakes in Required Minimum Distributions (RMD), Strategic Ways to Distribute Your RMD and Preparing for Retirement Plan RMD Season.)
One of the benefits of owning an IRA is the ability to transfer funds directly to beneficiaries without going through probate. Spousal beneficiaries can claim inherited IRAs as their own, a flexibility which allows the spouse to make new contributions to the IRA and control distributions.
"A spouse has lots of options when they inherit an IRA. They can make it their own IRA, or a beneficiary-designated IRA. The latter would occur if the spouse is under age 59½ and needed to take out money for whatever reason. A beneficiary account would avoid the 10% penalty owed on IRA distributions to owners who are under 59½," says Jillian Nel, CFP®, CDFA, director of financial planning, Legacy Asset Management, Inc., Houston, Texas.
Non-spousal beneficiaries cannot treat inherited IRAs as their own. They can't add to them and they must completely liquidate the account within five years of the death of the owner, or distribute the amounts over their life expectancies. Generally, the distribution options available depend on the age at which the IRA owner dies. Keep this in mind if you plan to leave IRA assets to your children or grandchildren. (To learn more, read Leaving Inheritance to Children Easier Said Than Done and Why Your Will Should Name Designated Beneficiaries.)
It is common for individuals to move accounts from one financial institution to another. If you just decide to maintain the same type of IRA account with a different company, you can move the assets as a transfer or as a rollover.
With a transfer, the assets are delivered directly from one financial institution to the other, and the transactions are not reported to the IRS. "When moving funds in your IRA ,you may do a direct transfer from one financial institution to another any number of times a year. Be aware that each firm may have account setup and close-out fees as well as an annual fee, so be aware of these charges when making firm changes," says Rebecca Dawson, a financial advisor in Los Angeles, Calif.
A rollover involves taking a distribution of the assets to yourself, and rolling over the amount within 60 days. "When a group retirement plan such as a 401(k) is rolled into an IRA, if the rollover is done the correct way, it can preserve some of the 401(k) plan benefits. This is why it can make sense to roll the 401(k) into a rollover IRA rather than a contributory IRA," says Kirk Chisholm, wealth manager at Innovative Advisory Group in Lexington, Mass.
You can also roll over your IRA assets to another type of retirement account, such as a 401(k), if such rollovers are allowed under the 401(k) plan. The plan would determine whether the rollover can be done as a 60-day rollover, or if the funds must be paid directly to the plan. (For more on rollovers, see Common IRA Rollover Mistakes.)
Financial services firms may charge annual fees on top of transaction fees for the purchase or sale of investments. In addition, they may charge administrative fees, which you may be able to deduct using 1040 Schedule A. Whether fees are deductible depends on whether they are paid with funds from within your IRA or with funds from outside of your IRA. (For related reading, see An Overview of Itemized Deductions and The Rap on Wrap Fees for Retirement Accounts.)
Your annuity can operate under the same rules as an IRA, if the funding vehicle is an individual retirement annuity. One benefit is that annuity policies were designed to provide retirement income for life. (For more on annuities, see An Overview of Annuities.)
Brokerage accounts allow you to give your financial advisor written authorization to make investing decisions and routine transactions without notifying you first. Often, a flat fee is charged for managing the account. This type of activity is allowed for IRAs, provided your broker has an agreement with you to allow such actions.
"I’m a real advocate for professional management of large IRA accounts. A quality investment advisor can build a low-cost custom portfolio and monitor it for necessary changes. They can draw upon thousands of proven investment options and adjust for changes in your situation, product innovations or changes in the economy," says Dan Danford, CFP®, Family Investment Center, St. Joseph, Mo. "As a professional, I worry when retirees have a large portfolio and seek to save money by going it alone. I’ve seen bad results too many times. In my mind, for most people, it’s penny wise and pound foolish."
The IRS limits which investment types can be held in an IRA, but your financial institution may have additional asset restrictions. For example, the IRS allows some gold and silver coins, but most financial institutions will not. Similarly, some mutual fund companies do not allow individual stocks to be held in their IRAs. (For related reading, see IRA Assets and Alternative Investments.)
Anyone who is under the age of 70½ for the year and is paid a salary, tips or hourly wages for their work (earned income) can contribute to a traditional IRA, including minors. This means your children can start saving for retirement as soon as they get their first jobs. An IRA is an excellent option for kids who earn more than they intend to spend, because it allows long-term tax-deferred savings.
"'When' you start investing outweighs 'how much' you invest," says Michelle Buonincontri, CFP®, CDFA™, New Direction Financial Strategies, LLC, Phoenix, Ariz. "Starting an IRA as a teenager, preferably a Roth IRA, if you have earned income, is an excellent idea. It can have a significant impact on your retirement savings by harnessing the power of compounding interest."
The tax penalty for early distributions will encourage your kids to defer taking distributions from the IRA, while offering the ability to use funds for college or up to $10,000 towards buying their first home without penalty. It also teaches your children the value of investing at an early age. (For more on setting up a savings plan for a child, see Retirement Savings Plans for Kids.)
Senior citizens can continue to contribute to Roth IRA accounts indefinitely. This is an excellent account for money that will eventually pass as an inheritance. However, once you reach age 70½, you can no longer make regular IRA contributions to traditional IRAs.
Individual retirement accounts have built-in flexibilities. Understanding how the various features work can help you tailor your retirement savings to meet your needs.