An individual retirement account (IRA) is an excellent way to save for the future and can grow both tax-free or deferred over time.
Distributions from an IRA account will become subject to income taxes once you reach retirement age, so how best can one avoid this scenario is uncertain and dependent upon a variety of factors.
1. Invest the Money in Other Investments
Investing money across multiple traditional IRAs may make withdrawing more straightforward and give you greater control of asset allocation. Consolidation could make future withdrawals simpler while giving more control of asset allocation – for instance if you own mutual funds that produce significant capital gains distributions moving them into your taxable account could reduce taxable income when withdrawing from an IRA.
If you anticipate having relatively large long-term capital gains, however, it might be more prudent to withdraw them gradually over your retirement and use up taxable investments before tapping into your IRA – thus avoiding an early withdrawal penalty of 10% in most instances (unless an exception applies). Furthermore, more liquid assets such as real estate, precious metals or art may be stored more conveniently within a taxable brokerage account than an IRA account.
2. Consult a Financial Advisor or CPA
Individual retirement accounts (IRAs) are offered by numerous financial institutions, including banks, brokers, insurance companies and robo-advisors. While the type of investments you choose for your IRA will ultimately determine its return and tax bill impact, there are certain strategies you can employ that can reduce it further.
These decisions may require professional advice, and are most effective when part of a comprehensive financial planning strategy.
Experienced financial advisors can assist in understanding your tax situation and the possible effects of withdrawing from an IRA, suggesting tax-efficient strategies, and may know of exemptions or deductions that you are eligible for that could save money long term.
3. Don’t Forget About Required Minimum Distributions (RMDs)
The IRS mandates that retirees withdraw at least a minimum amount from tax-deferred accounts such as traditional IRAs and 401(k) plans each year as part of a Required Minimum Distribution (RMD), calculated using both their account’s value as of December 31 of that year and life expectancy estimates. This withdrawal process is known as “Required Minimum Distributions (RMDs).”
Financial advisors or CPAs can assist with determining your Required Minimum Distributions and when it is best for you to take them. For instance, taking two RMDs within one year counts as taxable income and may cause you to enter a higher tax bracket; and rolling over funds between custodians will count as modifications subject to additional taxes.
4. Automate Your RMDs
Many IRA custodians can automatically calculate and withdraw RMDs at your required withdrawal age, helping you avoid costly tax penalties.
Use your RMDs to make charitable donations. After age 70 1/2, IRA holders can transfer up to $100,000 directly from their IRAs into charity each year (known as qualified charitable distribution or QCD) without impacting their adjusted gross income. This counts towards your RMD but won’t affect it in any way.
Finally, if you own a Roth IRA, once the required withdrawal has been met you may consider rolling it over into one to help avoid future RMDs and preserve assets longer in retirement. Speak to your financial planner about this option so they can create a strategy tailored specifically for your unique circumstances.
5. Transfer Your IRA to a New Provider
Individual Retirement Accounts (IRAs) offer tax advantages when saving for retirement. Contributions are tax deductible while investments grow tax-deferred until distributions at retirement when they’re typically taxed as income.
First-time homebuyers may withdraw up to $10,000 without incurring a penalty if the funds are used to cover “qualified acquisition costs”, including purchasing, building or rebuilding their home and any reasonable expenses associated with its acquisition. Distributions used to pay health insurance premiums won’t incur any additional penalty either.
At various brokerage firms and robo-advisors, opening an IRA is easy. Just find one that meets your needs, complete the opening process (which typically takes 15 minutes or less), provide your legal name, Social Security number and employer details – and begin investing!