With 2024 coming to a close, it’s an ideal time to refresh your knowledge of Individual Retirement Accounts (IRAs) and review your own IRA’s status, given the current contribution and distribution rules.

IRAs are IRS (Internal Revenue Service) approved methods of sheltering assets from certain taxes and can be a crucial component to many retirement plans.

Taxes can take a significant bite out of your finances, so it’s no surprise that IRAs have become a popular method for individuals to minimize their lifetime tax burden and save for retirement.

Understanding the “Subjective Spectrum” for Tax Advantaged Accounts

Tax advantaged accounts are typically part of what we call a “Subjective Spectrum.” To translate, the term means that each person or family has a different situation (subjective) and there is a range from the least tax-advantaged account/assets to the most tax-advantaged assets/accounts (a spectrum).

The LEAST tax-advantaged are your “non-qualified” accounts/assets, namely individual and joint savings accounts, other non-qualified brokerage and mutual fund accounts, CDs, interest bearing accounts, among others. These are subject to income and capital gains tax when realized. While these “taxable” accounts may contain investments that offer tax benefits, such as municipal bond interest and qualified dividends from stocks, the account structure itself doesn’t offer tax advantages.

On the other end of the spectrum, typically the MOST tax-advantaged accounts/assets are ones that can defer taxes and/or potentially eliminate certain taxes altogether. For instance, Health Savings Accounts (HSAs) offer a triple-tax advantage (deposits are tax deductible, growth is tax-deferred, and spending is tax-free). Somewhere in the middle of the spectrum lies the Roth IRA, Traditional IRA, life insurance, annuities, IRC Sec. 529 accounts for education, and charitable arrangements, which can be used strategically to lower your lifetime tax burden.

[For the curious readers, Trusts may occupy differing places along the spectrum, but more on those another time.]

IRAs as Part of a Holistic Retirement Plan

Many financial planners agree that holistic retirement plans include some sort of employer-sponsored retirement arrangement, which is usually tax-advantaged, such as a pension plan or a 401(k) or Roth 401(k) (or another of the numbered or lettered employer arrangements that you may have) but it should also include your own personal savings.

At the end of the day, the advice of a financial professional with a broad array of knowledge and experience who can tie together multiple aspects of your personal and professional life is crucial in navigating the landscape.

There are two major types of personal IRAs that the IRS makes available, Roth and Traditional.  The specific application and rules surrounding these two types of IRAs can be nuanced. With a Traditional IRA, you don’t pay taxes on the seeds, but rather, on the harvest. With a Roth IRA, the seeds are taxed, and not the harvest.

Generally, with a Traditional IRA:‍

• Contributions are tax-deductible, and you don’t pay taxes on these contributions until you withdraw funds, which is designed to be after age 59 ½
• For 2024, you can contribute up to $7,000 if you are under age 50, and an additional “catch-up” contribution of $1,000 if you are over age 50
• Contribution eligibility and tax deductibility depend on factors like filing status, adjusted gross income, and active participation in other retirement accounts
• Keep in mind that an IRA is not an asset or investment itself, but rather, the account type which assets may be purchased within
• For more information on IRA contributions, see IRS Publication 590-A

A key update from the SECURE Act 2.0, signed in 2022, raised the age for required minimum distributions (RMDs) to 73 (and will increase it to 75 in 2033). This provision enables Traditional IRA holders to continue making contributions even after RMD age, as long as they have earned income. If you are age 73 or older in 2024 and have pre-tax accounts, such as an IRA or 401(k), consider consulting with a CPA or financial advisor to ensure you comply with RMD requirements.

Ideally, you can take advantage of the tax-deferred nature of Traditional IRAs by taking taxable distributions after you are no longer earning as high an income as you were during your working years, thus, the income produced from a Traditional IRA distribution is likely taxed at a lower tax rate.

For older Traditional IRA owners, RMD rules are critical—missteps in calculating or timing distributions generally results in a hefty 25% IRS excise tax. Ensure you review and accurately aggregate all IRA accounts to take the correct distribution, or apply an exception correctly.

Importantly, Inherited IRAs have differing rules for RMDs; if you are a beneficiary of an IRA, or an administrator to estate containing an IRA, the IRA may be subject to required minimum distributions despite the beneficiary’s age. This area of the IRA rules is highly nuanced and hinges on the age of the decedent, named beneficiaries, and the status of beneficiaries. As such, you should review IRS Publication 590-B carefully, or contact an experienced financial professional or tax advisor immediately if this is your situation.

Keep in mind, if you must access funds from a Traditional IRA early, a drawback is that non-qualified withdrawals made prior to age 59½ will likely be treated as ordinary income, subject to ordinary income tax rates, plus an assessment of a 10% penalty. However, there are certain withdrawals you can make from a Traditional IRA without penalties, see IRS publication referenced above for details.

Generally, with a Roth IRA:

• Contributions are made with after-tax dollars (non-deductible from income)
• The contribution limits and “catch-up” provisions are the same as Traditional IRAs, and the limits aggregate across all IRAs (both Traditional or Roth – so if you have both types of IRAs, you cannot double your contribution amount)
• Earnings from a Roth IRA will NOT be taxed when you make qualified distributions, provided you have reached age 59 ½, and have had the Roth open for at least five years
• There are no age limits on contributions
• There are no required minimum distributions, so the assets in a Roth IRA can be kept in the tax shelter for longer
• Contribution eligibility depends on factors like filing status and adjusted gross income

The Roth IRA gets a lot of attention, and rightfully so; it is an excellent arrangement for many. Today, however, we won’t delve into the more esoteric topics such as Roth conversions and backdoor Roth contributions, among other strategies, but please know that the Traditional IRA and Roth IRA share many great qualities, such as their tax advantages and certain liability and bankruptcy protections. Plus, as you may know, contributions can be made after the end of the year for the prior year (April 15th is typically the deadline for a prior-year contribution, which does not include extensions) so this allows for post-December 31st planning and arranging of funds.

At the end of the day, IRAs can be great tools if used correctly, but even the slightest difference in your situation can make a significant impact in deciding what is best for you. It is always wise to seek help from knowledgeable professionals with significant experience in this area.

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Joseph M. Prisco Jr, JD, CFP® is the founder of Advocacy Financial, LLC. He helps clients manage and optimize their financial and estate planning affairs. For more information, or to consult with Mr. Prisco, call 888-787-4590 or write to him at jprisco@advocacyfinancial.com

Any opinions and forecasts expressed are those of the author, and may not actually come to pass. Information is subject to change at any time based on market and other conditions and should not be construed as a recommendation of any specific security or investment type.