Here are some of the fundamental aspects of Individual Retirement Accounts. IRAs can be broken down into two main categories: Traditional IRA and Roth IRA. With a traditional IRA, you contribute money to the account and get a tax deduction for the contribution. The money can then be invested tax free while in the account. Upon reaching age 70 ½ an account holder is required to take a minimum distribution. The amount you take is based on the size of the account and the life expectancy of the holder. These withdrawals are taxed at your then current income tax rate.
A Roth IRA is similar to a traditional IRA with a couple of key differences. First, you contribute “after tax” dollars. So you do not get a deduction for the contribution. The money can be invested on a tax free basis. However, upon withdrawal of the funds from the account, you do not pay income tax.
Generally, an IRA, whether traditional or Roth, has a designated beneficiary. Often the first beneficiary is a spouse, then children and so forth. If the account holder dies a spouse may generally rollover a traditional IRA account and treat it as his or her own account. At age 70 ½, the spouse is required to take minimum distributions from a traditional IRA. If a child or children inherit an IRA, they will be required to take minimum distributions based on his/her life expectancy. Often this is a fairly favorable strategy as the younger the beneficiary the smaller the minimum distribution. Small distributions often mean the majority of the funds in the account can continue to grow tax free over time.
In addition to tax savings, IRAs, both traditional and Roth, are in most cases completely protected from a person’s creditors. This fact makes an IRA one of the easiest and most common asset protection vehicles to create. And it’s available to most everyone!
One mistake to avoid though, do not allow your estate to be your IRA beneficiary. If this is the case, the entire account must be withdrawn faster. In such a case withdrawals must generally occur over a five year period. Such a situation will greatly increase your heirs’ tax burden, hinder the ability to grow the account tax free over a beneficiary’s lifetime and blunt the positive effects of asset protection.
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