Understanding IRAs

A Great Investment Tool with Many Tax Benefits
By: Jason Andrew, Financial Advisor 

This time of year, you see a lot of news about Individual Retirement Accounts (IRAs) because of their many tax benefits. Unfortunately, all this information often leads to confusion about how IRAs work and how they can benefit you.

We thought it was important to take a couple minutes and share a few brief yet important points to help provide some clarity on the potential benefits to you. In short, an IRA is a tax-favored way to save money for retirement.

IRAs come in two varieties, the Traditional IRA and the Roth IRA. The difference comes in the timing of the tax break. The Traditional IRA may provide an up-front adjustment to income; however, distributions from a Traditional IRA are taxed as ordinary income. While on the other hand, no deductions are permitted for Roth IRA contributions; nevertheless, withdrawals from a Roth IRA are potentially completely tax-free.

The great thing about both kinds of IRAs is your money either grows tax-free or tax-deferred and in most cases you can withdraw from them after the age of 59 ½ without penalty. The key differentiator is with Roth IRAs; tax-free distributions are possible at age 59 ½ and five years after the first tax year for which a contribution has been made.

If you do take early ‘premature’ distributions from either a Traditional or Roth IRA, you could be subject to an additional, nondeductible 10% tax penalty; however, it is reassuring to know there are many cases when you can withdraw funds from an IRA prior to retirement without penalty. We recommend you consult a tax and/or legal advisor prior to making such as decision.

At OFS Financial Services, we offer both Traditional and Roth accounts depending on what works best for your unique tax situation. It’s important to note that contributions to a Roth IRA are based on your income level. If you file taxes as a single person, your Modified Adjusted Gross Income (MAGI) must be under $139,000 for the tax year 2020 and under $140,000 for the tax year 2021 to contribute to a Roth IRA, and if you’re married and file jointly, your MAGI must be under $206,000 for the tax year 2020 and 208,000 for the tax year 2021.

The maximum total annual contribution for all your IRAs combined is $6,000 if you’re under age 50 and $7,000 if you’re age 50 or older. The deadline to contribute to your IRA is typically April 15 of the following tax year, so you may still have time to fund your IRA and possibly save on your taxes. Even better, with an IRA you can choose the investment vehicle that works best for reaching your financial goals.

Next month, I’ll be hosting a virtual webinar to provide more details about the options and benefits available through IRAs. In the meantime, to learn more, please feel free to schedule an appointment with me or call (360) 596-9788.

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Distributions from traditional IRAs and employer sponsored retirement plans are taxed as ordinary income and, if taken prior to reaching age 59½, may be subject to an additional 10% IRS tax penalty. A Roth IRA offers tax free withdrawals on taxable contributions. To qualify for the tax-free and penalty-free withdrawal of earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59½ or due to death, disability, or a first time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes.