Investing in an IRA

Tax shelters are financial arrangements made to decrease an investor’s taxable income, and by so doing, his or her tax liability. Tax shelters are legal and accepted by the government.

Tax shelters can range from investments, activities and investment accounts that command a favorable treatment of tax or lower taxable income all together. Examples of investment accounts with tax shelters are IRA (Individual retirement accounts), 401K.

Defer Tax with IRA

In this post, I would be analyzing the types of IRA’S, comparing the major ones and looking at some of the restrictions; I hope you enjoy. Traditional IRA’S have been around since the ERISA Employee retirement income security act of 1974. IRA can be likened to a pension, because it is meant for retirement savings. Aside the ROTH IRA, IRA’s are tax free at the point of depositing into your IRA account, but eventual withdrawal from an IRA is taxed as income; including the capital gains. The main point of it is that at retirement, overall income is likely to be lower, and this keeps you in a lower tax bracket; you thereby end up paying lower tax on the IRA.

Types of IRA

There are several types of IRA’S, and they include the traditional IRA, the ROTH, SIMPLE IRAs, SEP IRAs. In traditional IRA, you get your tax break at the time of depositing fund into your IRA account. Money withdrawn from your income for the purpose of IRA can be deducted from your taxable income in order to lower your taxable income, and ultimately your tax liability.

As for ROTH IRA’s, funds are taxed at the time of depositing into your IRA account, but at withdrawal, investment earnings are tax free. Named after Senator William V. Roth, Jr., the Roth IRA was introduced as part of the Taxpayer Relief Act of 1997.

A SEP IRA (Simplified Employee Pension Individual Retirement Arrangement) substitutes a pension plan, it is utilized by business owners to provide retirement benefits for themselves and their employees. it allows employers contribute to  traditional IRAS established in the employee’s name, instead of contributing to a pension fund in the employee’s name. Employers who can set up an SEP plan include sole proprietors, partnership, non-for-profit organizations, and corporations with one or more employees. The downside to an SEP plan for employers is that it must be set up for every employee that is eligible for the SEP IRA. How then do we determine eligibility for employees? Employees who meet the following requirement must be allowed to participate in the SEP plan if the employer chooses this plan.

• Attained the age of 21
• Earns at least $600
• Must have worked for the employer in at least three (3) of the Last five (5) years.

When lining up the traditional IRA against the ROTH IRA, we look at the tax rate. If the tax rate during the accumulation face is at the same as at withdrawal, then the traditional IRA and the ROTH yield the same amount; the reason being that the upfront tax deduction on the traditional IRA offsets the tax exemption on the roth’s earnings. If tax rates are not the same at accumulation and withdrawal, then one might end up being better than the other. If the tax rates are lower while withdrawing, then the traditional IRA would be worth more than the ROTH IRA; but if the tax rates are higher at withdrawal, then the ROTH IRA would be worth more than the traditional IRA.

An IRA is an exemplary investment tool for anyone looking to defer tax on his investment, but it is noteworthy to mention that they have restrictions which may not augur well with everyone. Some restrictions for the traditional IRA include:

How IRA can defer Tax

1) Income & Contribution Restrictions: IRA has some restrictions on income, and under some certain conditions, the restrictions may be tighter. An IRA contribution is fully deductible if your income or combined income (for joint fillings) is under a certain level, or if you do not have another retirement plan like an employer sponsored plan. For a single individual who is less than 50 years old earning a modified adjusted gross income of $61,000 and under, the maximum contribution to an IRA for 2016 is $5,500; while for an individual in the same income range but above 50, the maximum contribution becomes $6,500. For married couples less than 50 years of age, and with joint filings and earning a modified adjusted gross income of $98000 (for only one spouse) or $184,000 (if both participate) , the maximum contribution to an IRA for 2016 is $5,500, and $6500 if they are older than 50 years. The allowable contribution reduces as your income increases until it fades out completely.

2) Withdrawal terms (Distribution): Distribution means withdrawing from your IRA. The rules for distribution depend on the age you have attained at the time of distribution. If you withdraw your money at an age less than 59.5 yrs., you pay the federal and state taxes, alongside a 10% penalty. There are some exemptions to this rule, for withdrawals for first time buyer to a limit of $10,000, death benefits paid to the next of kin or heirs of the IRA holder, and un-reimbursed medical expenses. If you attain the age of 59.5 Yrs. at the time of withdrawal, then you pay only the state and federal taxes without paying any 10% penalty.

If you exceed the income limit of contributing to an IRA, you could contribute funds to a traditional IRA, but it won’t be tax deductible. To benefit from the IRA, you could then convert it to a ROTH which requires tax to be paid up front. Since an IRA for example can be converted to another (ROTH), individuals can take advantage of this by converting a traditional IRA to a ROTH IRA during periods of unusually low income, and then convert it back to traditional IRA when income picks and their marginal tax rate rises.
Most people argue that a traditional IRA is better than a ROTH because a traditional IRA defers taxes till retirement, and at retirement income is lower, implying a lower tax rate for the individual. This may not always be the case if the tax rate fluctuates or if the federal government seeks to increase tax rates to finance its debt obligation.

Rollover your IRA to Gold

Rolling over your IRA to a precious metal, preferably gold, allows you to mitigate the risk of fluctuating returns and market crashes as typical IRA funds are invested in securities such as stocks, CDs, mutual funds, bonds and so on. With Gold being one of the most stable investments you can make, there is no brainer on why you need to convert your IRA investment to gold. Although an IRA may allow you choose stocks and bonds similar to owning gold (for example buying stocks of gold mining companies or purchasing exchange traded funds that owns nothing but gold), there is nothing like owning physical gold or other precious metals as they are not only stable or reliable, but also appreciate in value with time.

To be able to rollover your IRA to purchase physical gold or other precious metals, you need to set up a self directed IRA. A self directed IRA is still an IRA but it avails the owner the liberty to invest in more assets or securities than the traditional IRA does. With a self directed IRA, you can purchase precious metals like gold and silver if you follow the IRS rules.

Moving your IRA to physical gold is as simple as ABC. you just need to roll the funds over from your traditional IRA to your self directed IRA. The IRS lets you roll over IRA funds once every 12 months, and you can avoid paying taxes if the money moves from the first IRA to the second IRA within 60 days.

Recommended Readings

Twila Slesnick., IRAs, 401(k)s & Other Retirement Plans: Taking Your Money Out

Mr Matt Sorensen., The Self Directed IRA Handbook: An Authoritative Guide For Self Directed Retirement Plan Investors and Their Advisors