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Individual Retirement Accounts

Individual Retirement Account (IRA) Plans
The "traditional" IRA, is funded with pre-tax dollars. The earnings grow tax-deferred (tax isn't due until distributions) and contributions may be tax-deductible under certain circumstances.

The general tax rules described below are the federal income tax rules as of January 1, 2014 and may be subject to exceptions. Always check your state (and local) income tax rules on IRAs. Finally, since tax laws may (and probably will) change from time to time, always check with your tax advisor before making major decisions regarding your IRAs.

Individuals need to have earned income (e.g., wages, salary, net self-employment income or taxable alimony) to be eligible to contribute to a traditional IRA. Your contributions must stop in the year you reach age 70.

Contribution Limits
Contributions are based upon earned income. In order to calculate the amount of the contribution:

1. You can contribute up to the lesser of (1) $5,500 or (2) 100% of your earned income. The $5,500 per person annual contribution limit is a maximum that applies to the total contributions to both traditional and Roth IRAs. For example, you could contribute $2,750 to a Roth IRA and $2,750 to a traditional IRA, making a total of $5,000 in IRA contributions. However, you could not contribute $3,000 to one type and $2,750 to the other since that sum would be larger than the $5,500 annual limit.
2. Married couples can contribute up to a total of $11,000 per year. If you're married and only one of you is working (or has a high enough income), then the non-working/lower-earning spouse can also contribute up to $5,500, provided the combined contribution (e.g., $5,500 for each of you) is not larger than the earned income.
3. Individuals don't have to contribute every year. You decide which years you want to contribute to an IRA.
4. If you are 50 years old or older this year, you're allowed to contribute an additional $1,000 under the "catch-up" provision bringing the total contribution limit to $6,500.
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Deductibility of Contributions
While anyone with earned income may make a contribution to a traditional IRA, only some contributions may be tax-deductible. The deductibility depends upon your income level, whether you're an active participant in an employer-sponsored retirement plan (e.g., 401(k) or pension plan), and your income tax filing status.

If neither you nor your spouse participate in an employer-sponsored retirement plan or if you're single and don't participate, you may deduct up to the maximum contribution:
1. Single persons who are active participants in an employer-sponsored retirement plan and have a modified adjusted gross income of no more than $114,000 in 2014 may make the maximum IRA contribution and deduct it.
2. Married couples filing jointly who are active participants in an employer-sponsored retirement plan and have a modified adjusted gross income of no more than $181,000 in 2014 may make the maximum contribution and deduct it. For a married person filing separately (who lived at least part of the year with his or her spouse and either spouse was an active participant in an employer-sponsored retirement plan), the deduction is reduced for income between $0 and $10,000, and then it is eliminated completely. If you live apart from your spouse the entire year and file an income tax return as a married person filing separately, you calculate your IRA deduction as if you were single. Your spouse's participation in a plan is ignored.
3. If one spouse is an active participant in an employer-sponsored retirement plan and the other isn't, then the non-working spouse may make a deductible contribution if the joint income is no more than $181,000. The deduction is reduced for income between $181,000 and $191,000. Then it is eliminated completely.
You are always 100% vested with a traditional IRA.

Benefits of an IRA
1. Contributions may be up to $5,500 per year (up to $10,000 for married couples, including a contribution for a non-working spouse)
2. Contributions may be tax deductible
3. Earnings are tax-deferred without any reduction for income tax each year
4. Contributions don't need to be made every year
5. You may be eligible to convert to a Roth IRA
6. Special creditor protection may be available
Possible Drawbacks of an IRA
1. Distributions of earnings and tax-deductible contributions are taxed at ordinary income tax rates (from 15% to 39.6% for federal tax plus state tax as of January 1, 2014). However, distributions of non-deductible contributions are income tax free
2. The tax deduction for contributions may be limited or eliminated if your income is over a certain limit and you are an active participant in an employer-sponsored retirement plan
3. Contributions stop at age 70
4. Distributions must start by April 1 of the year after reaching age 70
5. You can't borrow from an IRA
Timing of Distributions
Traditional IRAs have mandatory distribution deadlines (the law calls for the first required distribution to occur by age 70). You may face penalties if you receive a distribution too early (before age 59) or too late. You must take the mandatory amount (also known as required minimum distribution or RMD) no later than April 1 of the year after the year you reach age 70. So, if you reached age 70 in the year 2013, your first mandatory distribution must be made by April 1, 2014. If you don't take a required minimum distribution on time, there is a 50% penalty on the portion that should have been distributed. Required minimum distributions are mandatory each year after you reach age 70.

You may start taking distributions before age 70. It is important is to plan ahead for distributions before you reach age 70. Here's why. In the example above, the first distribution was taken on April 1, 2014. That was a distribution for the year 2013. Another distribution will need to be taken by December 31, 2014 (for the year 2014). By waiting until the year after age 70 was reached to take the first required distribution (for the year 2013), two distributions (for 2013 and 2014) would be made in one taxable year (increasing taxable income and the possibility of moving to a higher income tax bracket). Instead, the first distribution could have been taken in the year 2013 to avoid a bunching up, or doubling, of income in the year 2008 and thereby possibly decrease the income tax due on the two distributions.

By age 70, you need to choose your method of distribution and your designated beneficiary. These choices can affect the payout options for you and your beneficiary. Consult with your tax advisor for guidance on these issues.

Income Taxes
Distributions of earnings and tax-deductible contributions are usually subject to federal and state ordinary income tax ( the federal rate is from 15% to 39.6%, as of January 1, 2014). In the special case of non-deductible contributions to a traditional IRA for which no income tax deduction was taken, the distribution of those after-tax contributions is not subject to income tax (however, income tax is still due on the earnings from those non-deductible contributions).

Income Tax Penalties
Penalties can apply in these cases:
1. Making too large a contribution can be subject to a 6% excise tax
2. Withdrawing too little once the age 70 distribution rules apply can result in a 50% penalty
3. Taking a distribution before you reach age 59 is subject to a 10% penalty unless an exception applies (see below)
Exceptions to Early Distribution Penalty
Distributions of contributions or earnings before age 59 will be subject to a 10% penalty unless:
You are disabled or
Your beneficiaries are receiving distributions due to your death or
You are using the funds (up to $10,000) for a first-time home purchase or
You are using the funds for qualified educational expenses for yourself, your spouse, your children, your spouse's children, your grandchildren or your spouse's grandchildren or
You are taking the distributions under an approved annuity formula or
You are paying medical expenses in excess of 7.5% of your adjusted gross income or
You are paying health insurance premiums during a year where you are unemployed for more than 12 consecutive weeks or
You are taking a distribution of after-tax contributions or
You make a qualifying rollover to another IRA
The term "first-time home purchase" means you didn't own part or all of a principal residence in the two-year period before buying the new house. This $10,000 amount is a lifetime limit and is not an annual limit.

Beneficiary Designations
Legal and tax advice is useful when determining how to complete beneficiary designations. Properly completed designations can help save estate (death) tax, avoid probate, allow better income tax opportunities and avoid creditor claims on retirement assets.

Extra care needs to be taken in naming trusts as a beneficiary of most retirement assets in case of a death. Sometimes, naming trusts as a beneficiary can trigger income tax sooner than it would otherwise be owed and reduce the amount ultimately shielded from death tax.

Note that many plans require the participant's spouse to be the beneficiary, unless the spouse provides written permission for another beneficieary to be named.

Creditor Protection
Retirement plans and accounts may have special creditor protection under federal and/or state laws. Different types of plans and accounts may have varying degrees of protection. State protection rules may also vary from state to state.

If you convert from one type of plan to another (e.g., from a traditional IRA to a Roth IRA), you may be changing how much protection you have. This may be also be the case if you move to another new state where the new state rules are different.

Consulting with an attorney for guidance on the creditor protection issue may be helpful.

Estate and Death Taxes
Retirement assets are added to your other assets and may be subject to federal and/or state death (estate) tax. It depends upon the size of your overall estate and the estate planning done for you. Consult with your advisor about ways to defer or avoid estate tax.

For more information:
If you'd like more information about how diversified investment advisors can help you achieve your financial objectives through personalized wealth or retirement and risk management strategies, please contact us. We welcome the opportunity to discuss your unique needs and how we may best meet them.

This page (formatted for versions 10.0 and higher of Internet Explorer) is updated regularly so check in from time-to-time to see new articles and updates. You can click on any underlined words on each page to see a specific wealth management topic in the left margin of each page.

Charles M. Bloom, Registered Principal offers securities and advisory services through Centaurus Financial, Inc. - Member FINRA and SIPC - 775 Avenida Pequena, CA, 93111 (mailing address: 3905 State Street Suite 7173, Santa Barbara, CA, 93105) - CA Life Insurance License No. 0A52786 - Centaurus Financial, Inc. and Shoreline Wealth & Investment Management are not affiliated companies.

The information contained in this web site is neither an offer nor solicitation of any security or service.


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