5 Smart Changes Everyone Should Know About IRAs: Personal Finance

(Stephen Walters)

An IRA is one of the best tools you can use to save and invest for retirement. When used wisely, tax benefits can save you a lot of money and put you in a better position to achieve financial prosperity in retirement. Here are five things everyone should know about IRAs.

1. Your tax bracket matters

Both Roth IRAs and traditional IRAs have great tax benefits, but they differ in when you get your tax break. With a Roth IRA, you contribute after-tax funds, so your investments are tax-deferred and you can get tax-free withdrawals in retirement. Technically, you contribute after-tax funds in a traditional IRA, but you may be eligible to deduct your contributions, so your tax deduction is still on the front end. When deciding which account you should choose, it should boil down to your current tax bracket versus your likely tax bracket when you retire.

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If your current tax bracket is likely to be lower than when you retire, it makes sense to use a Roth IRA because you can pay your taxes now instead of being more expensive later. If your current tax bracket is likely to be higher than your retirement tax bracket, you should use a traditional IRA, as it may be more helpful to take a tax cut now.

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2. If you make too much money to donate directly, you can use a backdoor Roth IRA

Eligibility to contribute to a Roth IRA is income limited. For tax year 2022, it’s $144,000 if you’re single, or $214,000 if you’re married and filing jointly. If you exceed the income limit, you can still use a Roth IRA through the “backdoor Roth IRA” method. To create a backdoor Roth IRA, you first contribute to a traditional IRA. Once you’ve done this, you’ll convert your traditional IRA to a Roth IRA.

Since you got tax deductions on the front end with a traditional IRA, you’ll pay income tax on the amount converted to a Roth IRA. This is how the IRS makes sure you don’t contribute to a traditional IRA, take a deduction, then convert to a Roth IRA and get tax-free retirement withdrawals.

3. There are exceptions to the early exit rule

Generally, withdrawals from your retirement account before age 59 1/2 are considered early withdrawals and will result in income tax owing, as well as a 10% early withdrawal penalty. However, there are some exceptions to the IRA’s early exit rules:

  • die
  • permanent disability
  • Qualifying Education Expenses
  • First-time home buyer (up to $10,000)
  • Unreimbursed medical expenses over a certain amount

Early withdrawal from your retirement account should be one of your last resorts as it is a costly move, but in some cases – such as the first home buyer allowance – if not, using your retirement account funds may be Meaningful will resort to taxes or penalties.

4. Contributions can be made after the end of the year

In 2022, for those under 50, the maximum amount you can contribute to an IRA is $6,000. This includes Roth IRAs and traditional IRAs; you can only contribute $6,000 in total, not each person. Although contributions are based on a specific year, you do not have to make contributions until the end of that year. You must have it by April 15 (Tax Day) of the following year.Note, however, that if you are contributing for the 2022 tax year, you must contribute up to $6,000 by April 18, 2023 because the 15th is a weekend and April 17th is Emancipation Day in Washington, D.C.

5. You can contribute to your spouse’s IRA

Part of the IRA’s rule is that you can only contribute what you earn. Usually, if you’re not working, you can’t contribute to one of them — even if you’re technically rich. But there’s one exception: If you and your spouse file a joint tax return, if they don’t have any income, you can contribute to their IRA as long as you have. You can contribute up to $12,000 per year ($13,000 if one of you is 50 or older; $14,000 if you are both 50 or older).

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