subject: How To Save Money As An Ira Investor [print this page] If you are going to save money through your IRA investments, you need to make sure you are familiar with Tax Act and laws to ensure that you are not going to miss out on important ventures. This article will discuss IRA tax laws, and how to benefit from them.
After-tax IRA balances (also known as 'basis') grow in Individual Retirement Accounts (IRAs) from non deductible contributions and IRA rollovers of after-tax amounts. By saying non deductible contributions, we mean you pay taxes on all your earnings now, and will not be taxed when you withdraw them upon retirement, at 65.
This is how a Roth IRA works. Consider Jackson who earns a sixty five thousand dollar annual salary. Jackson is currently in the twenty five percent tax bracket and contributes thirty five hundred dollars a month to his Roth IRA.
Jackson would therefore pay income taxes of thirty five hundred x twenty five percent = eight hundred and seventy five and would contribute thirty five hundred - eight seventy five = twenty six hundred and sixty five to his Roth IRA. If Jackson expects to be in a thirty three percent tax bracket upon retirement, he will have to pay thirty five hundred x thirty three percent = eleven hundred fifty five upon his retirement.
Therefore, by making after-tax Roth IRA contributions now and getting taxed at the lower twenty five percent, Jackson avoids having to pay taxes at thirty three percent when he hits retirement. Distributions of after-tax balances (basis) is supposed to be tax-free.
However, if you fail to keep track of these amounts that you have contributed, any distributions you take will result in you having to pay taxes to the IRS resulting in double taxation. Also, if you do not file IRS Form 8606 (Nondeductible IRAs) to the IRS, you will owe them a penalty of fifty dollars unless you show a valid reason why you didn't file that form.
Consider this example: John made a rollover contribution of fifty thousand from his 401k plan to a Traditional IRA out of which fifteen thousand was contributed on an after-tax basis. This means distributions of this fifteen thousand should be tax free because John already paid taxes on them.
John, busy as he is, failed to file Form 8606 to the IRS and did not keep track of the amount. John withdrew his entire fifty thousand balance from his IRA due to some emergency and included the entire amount as taxable income.
This means John paid taxes on his fifteen thousand dollar contributions that should have been tax-free. Had John filed IRS Form 8606 in the year the rollover occurred, he would not have got double taxed on the fifteen thousand dollar distribution.
Once you make a nondeductible contribution to a Traditional IRA or rollover after-tax amounts, any distributions taken from the IRA will include a prorated amount of pre-tax and post-tax assets. These assets will be broken down into pre-tax and post-tax amounts just like how John has thirty five thousand dollars pre-tax assets and fifteen thousand of post-tax assets in his Traditional IRA.
Another important point to remember is that if you have multiple traditional, SEP or simple IRAs with different beneficiaries, you might want to maintain a separate Form 8606 for each type of IRA. Then, each beneficiary will be able to determine their basis (after-tax balances) in their inherited IRAs and file any IRS Form 8606.
Pre-tax IRA assets or balances that are not distributed before the IRA investor's death are not taxable to the deceased IRA owner. Instead, they will be added to taxable income of the beneficiary for current tax year.
However, these assets may be included in the deceased IRA investor's estate and subject to estate tax. However, if the deceased IRA owner filed IRS Form 706 (United States Estate and Generation-Skipping Transfer form), the beneficiary might be eligible for a federal tax deduction for the total amount of estate taxes listed on form 706.
This deduction is known as Income in Respect of Decedent (IRD) and is one of the most important deductions that a beneficiary could get with inherited assets or monies. Unfortunately, it is a deduction least aware of by IRA investors and owners.
As you can see, there are ways to save money when you are an IRA investor. You have to be smart, and plan for you future while you are young.
by: Jack Landry
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