In 1974, the federal government approved a bill that created a new type of financial savings account, known as an Individual Retirement Account to encourage people to save for retirement. Today these initial IRAs are known as traditional IRAs and can be opened at banks, credit unions, investment firms and other financial institutions. These firms are known as custodians.
Individuals can lower their taxable income by putting money into traditional IRAs every year. These funds earn ongoing interest and generate income but IRA owners can delay paying any income tax on their annual deposits or earned money until they turn 70½ years of age. For many people, their age 70½ tax bracket is much lower than when the money was earned resulting in lower taxes when the money is withdrawn. At that point, they must begin withdrawing a portion of the money each year. These funds are considered income and are taxable. If for some reason a person chooses to withdraw money at an earlier age, a penalty is assessed by the Internal Revenue Service.
“Traditional IRAs include a wide range of investment opportunities, including stocks, bonds, mutual funds, annuities, unit investment trusts and exchange-traded funds,” said Mark Dunsmoor, senior vice president of Legacy Bank. “As companies started eliminating pension benefits, IRAs helped the average person invest in these products with tax savings to better prepare them for their future.”
To help those closer to retirement, allocation amounts are increased based on age. “If you are under 50, you can deposit up to $6,000 yearly into a traditional IRA as of 2019,” said Dunsmoor. “If you are over 50, you may deposit up to $7,000.”
“Since 1974, changing regulations have morphed IRAs into several different types of investment accounts, however the logic remains the same for each; save money for retirement while reducing your taxes,” said Dunsmoor. “Yet, all IRA accounts do not utilize the same tax advantages. The Roth IRA is a great example.”
Individuals can deposit funds into a Roth IRA and pay income taxes upfront on the initial investment. However, later when the owner withdraws those funds, no further taxes are paid on the financial growth.
“Roth account owners who withdraw after 59½ years of age and whose accounts have been open for five years or more pay no taxes on any funds withdrawn. Equally important, you are not required to start withdrawals at 70½ as with a traditional IRA,” said Dunsmoor. “Roth IRA’s appeal to people who believe their tax rates at retirement age will actually be higher than when they opened the Roth IRA.”
In 2019, the annual contribution levels for a traditional IRA and the Roth IRA are the same. Roth contributions however, are limited to the extent of your income versus the $6,000 to $7,000 for a traditional IRA. For example, if you earned $4,000 in income that is the most you can contribute. The IRS also places restrictions on high income earners using a formula known as modified adjusted gross income and tax-filing status.
Mark Dunsmoor is the senior vice president of Legacy Bank and has 40 years of banking expertise. He has been recognized by Greater Pueblo Chamber of Commerce which presented him with the Charles W. Crews Business Leader of the Year.
Article featured in the Pueblo Chieftain: Link to Article