IRAs: Build a tax-favored retirement nest egg
Although traditional IRAs and Roth IRAs have been around for decades, the rules involved have changed many times. The Secure 2.0 law, which was enacted at the end of 2022, brought even more changes that made IRAs more advantageous for many taxpayers. What hasn’t changed is that they can help you save for retirement on a tax-favored basis. Here’s an overview of the basic rules and some of the recent changes.
Rules for traditional IRAs
You can make an annual deductible contribution to a traditional IRA if:
- You (and your spouse) aren’t active participants in employer-sponsored retirement plans, or
- You (or your spouse) are active participants in an employer plan, and your modified adjusted gross income (MAGI) doesn’t exceed certain levels that vary annually by filing status.
For example, in 2024, if you’re a joint return filer covered by an employer plan, your deductible IRA contribution phases out over $123,000 to $143,000 of MAGI ($77,000 to $87,000 for singles).
Deductible IRA contributions reduce your current tax bill, and earnings are tax deferred. However, withdrawals are taxed in full (and subject to a 10% penalty if taken before age 59½, unless one of several exceptions apply). Under the SECURE 2.0 law, you must now begin making minimum withdrawals by April 1 of the year following the year you turn age 73 (the age was 72 before 2023 and 70½ before 2020).
You can make an annual nondeductible IRA contribution without regard to employer plan coverage and your MAGI. The earnings in a nondeductible IRA are tax-deferred but taxed when distributed (and subject to a 10% penalty if taken early, unless an exception applies).
Nondeductible contributions aren’t taxed when withdrawn. If you’ve made deductible and nondeductible IRA contributions, a portion of each distribution is treated as coming from nontaxable IRA contributions (and the rest is taxed).
Amount you can sock away
The maximum annual IRA contribution (deductible or nondeductible, or a combination) is $7,000 for 2024 (up from $6,500 for 2023). If you are age 50 or over, you can make a $1,000 “catch-up contribution” for 2024 (unchanged from 2023). Additionally, your contribution can’t exceed the amount of your compensation includible in income for that year.
Rules for Roth IRAs
You can make an annual contribution to a Roth IRA if your income doesn’t exceed certain levels based on filing status. For example, in 2024, if you’re a joint return filer, the maximum annual Roth IRA contribution phases out over $230,000 to $240,000 of MAGI ($146,000 to $161,000 for singles). Annual Roth contributions can be made up to the amount allowed as a contribution to a traditional IRA, reduced by the amount you contribute for the year to non-Roth IRAs, but not reduced by contributions to a SEP or SIMPLE plan.
Roth IRA contributions aren’t deductible. However, earnings are tax-deferred and (unlike a traditional IRA) withdrawals are tax-free if paid out:
- After a five-year period that begins with the first year for which you made a contribution to a Roth IRA, and
- Once you reach age 59½, or upon death or disability, or for first-time home-buyer expenses of you, your spouse, child, grandchild, or ancestor (up to a $10,000 lifetime limit).
You don’t have to take required minimum distributions from a Roth IRA. You can “roll over” (or convert) a traditional IRA to a Roth IRA regardless of your income. The amount taken out of the traditional IRA and rolled into the Roth IRA is treated for tax purposes as a regular withdrawal (but not subject to the 10% early withdrawal penalty).
There’s currently no age limit for making regular contributions to a traditional or Roth IRA, as long as you have compensation income. Contact us if you have questions about IRAs.
© 2024
Facing a future emergency? Two new tax provisions may soon provide relief
Perhaps you’ve been in this situation before: You have a financial emergency and need to get your hands on some cash. You consider taking money out of a traditional IRA or 401(k) account but if you’re under age 59½, such distributions are not only taxable but also are generally subject to a 10% penalty tax.
There are exceptions to the 10% early withdrawal penalty, but they don’t cover many types of emergencies.
Good news: Beginning in 2024, there will be new relief for some taxpayers facing emergencies. The SECURE 2.0 law, which was enacted late last year, contains two different relevant provisions:
1. Pension-linked emergency savings accounts. Employers with 401(k), 403(b) and 457(b) plans can opt to offer these emergency savings accounts to non-highly compensated employees. For 2024, a participant who earned $150,000 or more in 2023 is a highly compensated employee. Here are some more details of these new type of accounts:
- Contributions to the accounts will be limited to up to $2,500 a year (or a lower amount determined by the plan sponsor).
- The accounts can’t have a minimum contribution or account balance requirement.
- Employers can offer to enroll eligible participants in these accounts beginning in 2024 or can automatically enroll participants in them.
- Participants can make a withdrawal at least once per calendar month and such withdrawals must be made “as soon as practicable.”
- For the first four withdrawals from an account in a plan year, participants can’t be subject to any fees or charges. Subsequent withdrawals may be subject to reasonable fees or charges.
- Contributions must be held as cash, in an interest-bearing deposit account or in an investment product.
- If an employee has a pension-linked emergency savings account and is not highly compensated, but becomes highly compensated as defined under tax law, he or she can’t make further contributions but retains the right to withdraw the balance.
- Contributions will be made on a Roth basis, meaning they are included in an employee’s taxable income but participants won’t have to pay tax when they make withdrawals.
2. Penalty-free withdrawals for emergency expenses. This new provision is another way to get money for emergencies. As mentioned earlier, taking a distribution from an IRA or 401(k) before age 59½ generally results in a 10% penalty tax unless an exception exists. SECURE 2.0 adds a new exception for certain distributions used for emergency expenses, which are defined as “unforeseeable or immediate financial needs relating to personal or family” emergencies.
Only one distribution of up to $1,000 is permitted a year, and a taxpayer has the option to repay the distribution within three years. This provision is effective for distributions made beginning in 2024.
Guidance likely coming soon
These are just the basic details of the two new emergency-related provisions. Other rules apply and the IRS will need to issue guidance to address certain details. Contact us if you have questions or need cash and want to explore the most tax-efficient ways to tap one of your accounts.