Retirement Money

Building Savings in IRAs: Tax Reforms Open New Opportunities

Retirement Money

As we've noted before, Congress has decided to make some significant changes in the U.S. tax code. Besides other sweeping reforms enacted, passage of the Secure Act at least in theory should create more opportunities for retirement savers to make better use of their traditional IRA accounts. 

A key provision in the act allows contributions to such IRAs past age 70.5, which was the previous limit. "The Secure Act opens use of traditional IRAs to anyone regardless of age," says John Dahlin, head of IFA Taxes, a division of Index Fund Advisors. "Now, you've got two different avenues instead of one to keep building a nest egg in a tax-friendly manner."

Given that a Roth lets you withdraw savings free from taxes after age 59.5, is that really going to wind up being a big deal? Remember, in a traditional IRA, you're going to owe the IRS -- at your personal tax rate -- for any money being withdrawn. 

Before making any major move, though, Dahlin suggests taxpayers understand key features offered by traditional and Roth IRAs. In both, your contributions are allowed to grow without being taxed each year such savings are kept in an IRA account. But in a traditional wrapper, you can deduct such contributions each year from your taxes, (subject to specific income limitations). In a Roth, that's not the case. 

So, wouldn't that make a traditional IRA a no-brainer as a taxable savings choice? Not necessarily, says Dahlin, who is a certified public accountant (CPA). He points out that Roths have become popular because of the end results involved in such savings vehicles -- namely, once you start dipping into a Roth account, you're not taxed. As a result, Roths represent a tax-free way to build retirement income. 

On the other end of the spectrum, once you start taking money out of a traditional IRA, you'll owe taxes according to your personal tax bracket rate. In retirement, that might be lower than when you were working. But that's why a traditional IRA is considered as a tax-deferred savings account, not tax-free. 

Again, the trade-off is fairly straightforward, at least on the surface. With a Roth, you can't take a deduction each year on your taxes. In return, however, any withdrawals after age 59.5 are tax-free. With a traditional IRA, you can get tax breaks on contributions each year up to that same age (and specific income limitations), but once you start using those savings you're going to owe taxes on any distributions (i.e., withdrawals). 

In both types of savings accounts, the money you put in will grow without being exposed to taxes. Still, why wouldn't someone simply choose a tax-free Roth over a tax-deferred traditional IRA?

"If someone expects his or her income to be less in retirement, then it might be better to use a traditional rather than a Roth IRA," Dahlin says. 

That's particularly the case for those earning relatively higher salaries, he adds.  "In choosing whether to use a traditional or Roth IRA, you need to estimate how much difference there is likely going to be between getting deductions over the course of your working life through a traditional IRA," Dahlin says, "as opposed to being able to make tax-free withdrawals after 59.5 years of age."

Provided their contributions qualify for a tax deduction, traditional IRAs might prove especially beneficial to younger professionals who expect to keep earning relatively higher wages well into their careers, the veteran CPA points out. "The longer you work, the more beneficial it might prove to keep taking deductions for your traditional IRA's contributions each year," Dahlin says. "That type of a strategy might actually help to lower your overall tax burden over a lifetime and lessen the appeal of holding more money in a Roth." 

No matter what income level you're presently at or age, the veteran CPA finds that many of his clients find it advantageous to use both. "In effect, you're taking much of the guess-work out of the retirement savings formula," Dahlin says, "and leaving both options available to optimize your overall tax situation."

For an introductory and complimentary discussion about your current tax situation, IFA Taxes can be contacted at (888) 302-0765. Feel free to get ahold of Dahlin via email by reaching out to him at: [email protected] 

This is intended to be informational in nature and should not be construed as tax advice. As a division of Index Fund Advisors, Inc., IFA Taxes provides a wide array of tax planning, accounting and tax return preparation services for individuals and businesses across the United States. IFA Taxes does not provide auditing or attestation services and therefore is not a licensed CPA firm. IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. Federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter herein.

Certified Public Accountant (CPA) is a license to provide accounting services to the public awarded by states upon passing their respective course work requirements and the Uniform Certified Public Accounting Examination.