The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) came into effect in 2020. This act includes changes that simplify access to retirement accounts for Americans, which, for many of us, is the only way to reduce our taxes. In this article, I will review the basics of IRAs and explain the latest changes.
REMINDERS ABOUT IRAS
An Individual Retirement Account (IRA) is a tax-deferred bank account, a mutual fund or broker, which we open for ourselves in order to deposit money for retirement. The tax benefit is that the money deposited into an IRA is a tax write-off for most people, and the money in the account grows with taxes deferred for the future, when we begin withdrawing the money (at best when we are retired), when we will be in a lower tax bracket. Starting in 2019, deposits of up to $6,000 can be made annually, plus an additional $1,000 for those over age 50. Married couples can deposit twice as much money.
IRAs are seemingly simple, but questions have been arising, so we will revisit the topic. Below are the answers to frequently asked questions.
WILL I GET A TAX WRITE-OFF?
Anyone can pay into an IRA, but only people who fulfill the following requirements qualify:
- For a single person (or if a spouse does not have a current retirement plan), deposits into IRA accounts are written off from taxes regardless of income.
- For those who have a retirement plan at work, deposits into IRAs are tax deductible if yearly income is less than $65,000 for a single person and $104,000 for those married and filing together. Tax write-offs are reduced income above this amount.
- Married persons having a retirement plan through their employer can pay into an IRA and add it to their write-offs if the combined income is less than $206,000.
HOW MUCH RETIREMENT MONEY WILL MY IRA PAY OUT?
An IRA will not pay out any Social Security or disability benefits. We only gain as much as we set aside with as much profit as the investment brings. Many Poles in America paid some money into an IRA many years ago, then held the money in a savings account and were later disappointed with the results. But wise investors do not establish accounts in banks but opt to establish mutual funds or in electronically traded funds (EFTs).
In the last twenty years, so from January 1, 1999, the Standard & Poor 500 (S&P 500) Market brought, on average, an 8.2% compounded annual growth rate (even with a few downturns); looking at the last thirty years, it brought a 12.1% return. If our funds kept up with this indicator, $4,000 deposited systematically each year for twenty years would yield $206,000 and in thirty years, because of the snowball effect, would result in $1.1M (not taking inflation onto account). And, slowly but surely, you can became a millionaire thanks to the compounded interest earnings added to the capital to bring additional untaxed income. Use the investment calculator to find out for yourself: indicator results of the S&P 500 for any time period can be found at www.moneychimp.com/features/market_cagr.htm.
WHEN CAN I MAKE WITHDRAWALS FROM MY IRA?
You can always withdraw from an IRA, but why would you want to lose the tax breaks? It is best to go with the snowball effect to accumulate equity and take advantage of the added earnings.
Due to the fact that the money in an IRA is yours, you can do with it as you please, however, any funds you withdraw are taxable. Additionally, if you are not yet 59½ years of age, you will have to pay a 10% penalty of the withdrawn funds. There are, however, some alternatives to paying the fine (also found in the book, Amerykańskie Emerytury). The SECURE Act allows you add/deposit $5,000 for a child’s birth or adoption or up to $10,000 for two parents into two accounts.
After 72 years of age, you are obligated to start taking minimum distributions from the account, which will be covered below.
HOW MUCH TAX DO I PAY UPON WITHDRAWAL FROM MY IRA?
Based on the financial status of the taxpayer, funds withdrawn from an IRA (and other retirement funds, except for the Roth IRA) are added to taxable income and taxed as income. Taxes are dependent on various factors: types and amount of income in a given year, taxpayer’s marital status, number of dependents, tax write-offs, and tax credits. To avoid any surprises, it is important to calculate all other tax obligations or speak with a tax specialist before deciding to withdraw all funds from an account.
WHY DO I HAVE TO PAY TAXES TWICE?
This is a common question of readers, pointing out that they have already paid taxes to their employers. Why the taxes upon closing an IRA?
In this case, it is important to note that thanks to tax write-offs, deposits into IRA are made before being taxed. Interest earned is also not taxed. The IRS wants its share, so it taxes funds withdrawn from the retirement account.
Conclusion: We pay taxes only once (or not at all if we add funds in a year in which we are in a zero percent tax bracket). Retirees with only Social Security and little or no additional income are in the zero percent tax bracket. In the book, „Jak oszczędzać na podatkach” (How to Save on Your Taxes), I explain the status of a retiree who has various sources of income, yet withdraws substantial amounts of money that is not taxed.
WHEN DO I BEGIN CASHING OUT MY IRA?
As you age, you should progressively cash your IRA out. The Required Minimum Distribution (RMD) has changed as a result of the SECURE Act. In the past, after reaching 70½ years of age, deposits into IRAs (and others, including 401(k), 403(b) and 457 accounts), were prohibited, and minimum distributions required, even if not needed by the owner of the account.
Recent changes: Beginning January 1, 2020, we are required to begin taking minimum distributions out of retirement accounts at age 72. Of course, we can withdraw the money earlier, but after our 72nd birthday, we are required to cash out the account based on our anticipated life span. Our bank or trust fund should send written notification of such obligations.
The new rules apply to those who were born after July 1, 1949; those who are older must follow earlier regulations: the first RMD must be made before April 1 of the year in which they reach the age of 70½ and the following distributions prior to December 31 of each subsequent year. Neglecting the minimum withdrawal results in a 50% penalty of the amount of the withdrawal.
CAN A RETIREE STILL PAY INTO AN IRA?
Anyone who has earned income, meaning a salary from working, business income, commissions or honoraria, can deposit into an IRA. Bank interest and dividends are considered passive income and cannot be included in an IRA.
Prior to 2020, deposits were prohibited after the age of 70½, even if a person still had earned income. Currently, deposits can be made into retirement accounts as long as you want, even until after age 72, so as long as you have income from an employer. The age limit was eliminated so you can save as much as you wish.
You can pay into a retirement account as a nonworking spouse if you are retired but your spouse is still employed, provided that you and your spouse’s deposits do not exceed your spouse’s income.
It is well worth it to open and deposit money into various retirement funds, invest them well and allow for them to increase in value. In our old age, they’ll certainly come in handy.
About the author
Elżbieta Baumgartner is the author of numerous books and guides, including (in Polish) „Powrót do Polski”, „Emerytura reemigranta w Polsce“ (podręcznik seniora wracającego do kraju), „Ubezpieczenie społeczne Social Security.” More information for our Polish-speaking members can be found on Ms. Baumgartner’s website: www.poradniksukces.com.