2014 IRA Contribution and Distribution Rules

People in the accumulation phase of their working lives are often concerned about “maxing” out individual retirement account (IRA) contributions while retirees are concerned about annual required minimum distributions (RMD). Whether contributing or withdrawing, the amounts change almost annually due to inflation protections and life expectancy tables. Below is a discussion on 2014 traditional IRA rules.

2014 IRA Contribution Considerations

A traditional IRA is a fantastic retirement tool that allows tax deductions for those contributing and tax-deferred growth on investments. IRA rules also allow those investors nearing retirement age (50 years and older) to contribute more to their IRA plans than someone younger. If you are engaged in 2014 retirement planning, below are the IRA contribution limits for 2014:

• $5,500 for those below age 50
• $6,500 for those above age 50
• Anyone age 70 ½ + cannot contribute to a traditional IRA 

In order to contribute to an individual retirement plan, one must earn a taxable income. In other words, in order to contribute $5,500, for example, a person must have made at least $5,500 in taxable income.

2014 IRA Distribution Considerations

If you are a retired traditional IRA investor over age 70 ½ or you have inherited a traditional IRA, you are probably considering your 2014 required minimum distribution (RMD) amount. While investment growth of a traditional IRA is tax-deferred, withdrawals are considered ordinary income. A required minimum distribution is calculated based on the total IRA account balance and your life expectancy or the life expectancy of who you inherited it from. Please keep in mind a few other IRA withdrawal considerations outside of retirement and inheritance:

• As a broad rule, taking a distribution from a traditional IRA account before age 59 ½ will result in a 10% IRS penalty. Consult your tax expert for more specifics on penalty exclusions. 
• ROTH IRA accounts do not have required minimum distributions.
• The penalty for missing your 2014 RMD is 50% of the difference between what should have been distributed and what actually was. 
• There is no penalty for withdrawing more than your required minimum distribution. 

While it may feel like 2014 is almost over, IRA contributions can be made until April 15^th 2015. This allows anyone planning for retirement to consult with his or her tax advisor to choose the most tax-advantaged amount of contribution or withdrawal based on concrete 2014 taxable income calculations. 

Retirement Plan Integration with Self Directed IRAs

Whether you’re getting close to retirement age or you’re just beginning to look into retirement planning, it is important to understand how each type of retirement account fits into your overall retirement plan. Common retirement accounts, such as the Traditional IRA, Roth IRA, and HSA, each play their own role in a well-rounded retirement strategy. Knowing how to utilize each type of account will allow you to develop the best retirement plan for your personal retirement goals.

Each plan type offers a different tax advantage. Traditional IRAs are traditionally thought of as providing tax advantages when funds are placed in the account, and Roth IRAs delay the advantages until funds are removed from the account. While this is generally true, there are many factors that can affect the personal advantages of any particular account. These factors can include the age at which you plan to retire, your current tax bracket, the tax bracket you will be in post-retirement, the cost of living where you plan to retire, and the performance of other investments outside of your retirement accounts. A study of each account’s tax advantages and how those advantages will interact with the factors above may help you to create a personalized retirement plan.

For self directed IRA account holders, determining which accounts will best suit your retirement goals can seem complex. Just because you have a self-directed account does not mean you are alone on your retirement journey. SDIRA account holders can utilize the services of Certified Public Accountants (CPAs), Certified Financial Planners (CFPs), RIAs, trusted friends, and others to form a financial team. This team can help you discover the right combination of retirement accounts for your goals while you maintain the independence that comes with self-direction.

One account to consider for your well-rounded retirement plan is a Health Savings Account. An HSA can help you plan for those medical bills that may be incurred after you retire, allowing you to use your IRA funds to pay for other things. Not only can your HSA help you save for future medical costs, but you may also invest your funds to help grow your account’s value. The HSA also provides another advantage. After the account is opened, any medical costs incurred and paid out-of-pocket may be reimbursed from the HSA at any time in the future. Your financial team can help you determine how best to utilize a HSA as part of your plan.

New Direction IRA is proud to be a part of your personalized retirement plan. The self directed IRAs and HSAs we provide allow you to diversify your retirement investments, use your personal expertise to invest in what you know, and adjust to changing market conditions. We offer education to account holders and non-account holders alike, as well as providing continuing education to CPAs, CFPs, and other members of your financial team so you can make the best decisions possible for your self-directed retirement plan.

The 5-year rule for Roth IRA withdrawals

If you’re one of many investors contributing to a Roth IRA or considering a Roth Conversion for an existing pre-tax retirement account, it’s important to understand exactly how the “Five Year Rule” works. Below is a short explanation of how the rule affects your IRA distributions.

What is the Five Year Roth Rule?

The five year Roth rule refers to a five year period that restricts tax-free distributions on the earnings/gains in a Roth IRA and distributions of converted funds in a Roth IRA. If a Roth IRA achieves gains in addition the contribution amount(s), distributions of those gains before the five year waiting period will be taxable. Similarly, funds that are converted from a “pre-tax” retirement plan to a Roth IRA must wait five years in order to be distributed tax-free. The five year period begins when an IRA holder opens a Roth IRA and begins making contributions OR when a new Roth Conversion is performed. In either event, the actual effective date of the five year Roth rule is always backdated to January 1 of the tax year the event takes place. This can be important because if you time things right, your wait time can actually be reduced by more than 20%. Let’s take a look at some math below to get a clearer understanding.

How is the Five Year Roth Rule Calculated?

New Roth IRA Example: If I start a Roth IRA in April, 2012 (remember to backdate) and begin making annual contributions beginning in the tax year of 2011, my five year time clock will have ended on January 1, 2016. Notice that my effective wait time was less than four years, not five. My wait period begins January 1, 2011, not April, 2012.

Traditional to Roth Conversion Example: If I have an existing Traditional IRA , it’s possible for me to perform a Roth conversion. To perform this process, I pay tax on the amount being converted in order to change my retirement funds from “pre-tax” to “post-tax”. I claim the converted amount on my tax return for the tax year in which I perform the conversion. Once I start this process, the five year rule begins. Just like before, the later in the year I perform my conversion, the more my five year rule becomes a four year wait.
It’s important to note that I must perform my conversion before December 31st or the tax year will effective change. For example, if I’d like my conversion to represent the tax year of 2012, I must complete my 2012 conversion before December 31st, 2012. Conversions made between January 1 – April 15th cannot be backdated to represent conversions in the prior year even though filing deadlines take place in April.

How does the Five Year Roth Rule affect my distributions?

As I mentioned above, the five year rule dictates that distributions, over and above the amount contributed and/or the amount converted, that are taken prior to the five year wait period after the establishment/conversion of the account are not tax-free. See the examples below for a comparison of scenarios.

John, at 57 years of age, makes a maximum contribution of $6000 to his Roth IRA on April 15, 2007 for the tax year of 2006. On January 1st, 2011, John decided to withdraw $8000 from his Roth IRA. Of the $8,000 that John withdraws, $6,000 is principle contribution and $2,000 is profitable earnings. 
Results: Since John is now over the age of 59.5 and his five year rule has expired (Jan 1, 2006 – Jan 1, 2011), the entire distribution is qualified for a tax-free distribution and isn’t included as taxable-income. In the example above, John made a profit of $2,000 over a period of almost four years but because his first contribution in the Roth IRA was dated back to January 1, 2006, his wait for tax-free distributions was considerably shorter than 5 years.

**Note that he was over the required age of 59.5 for tax-free distributions as well.

Now let’s look at the same example if John takes his distribution after only 3 years of participating in a Roth IRA:

John, at 57 years of age, makes a maximum contribution of $6000 to his Roth IRA on April 15, 2007 for the tax year of 2006. On January 1st, 2009, John decided to withdraw $8000 from his Roth IRA. Of the $8,000 that John withdraws, $6,000 is principle contribution and $2,000 is earnings. Even though John is now over the age of 59.5, his distribution on the earnings is being taken out of the account before the five year rule expires. $2,000 of his distribution must be claimed as taxable income on his tax return.
Results: After age 59 1/2 and once the five-tax-year holding period is met, any distribution from the Roth IRA will be considered a qualified distribution and be tax-free. Remember that each conversion from a pre-tax IRA will start its own individual five year waiting period. You may consider keeping any conversions and/or contribution accounts separated in different Roth IRAs for organization purposes.