Individually managed retirement savings plans are set up and managed by each individual taxpayer. More commonly known as Individual Retirement Accounts (IRAs). IRAs were first authorized by the Employee Retirement Income Security Act of 1974 (ERISA). Originally, IRAs were limited to workers without pension coverage, but the Economic Recovery Act of 1981 made all workers and spouses eligible to have IRAs.

An IRA is long-term retirement savings account or annuity that you establish directly with a financial institution, such as a bank, brokerage, insurance, or mutual fund company (the “fiduciary”).

The amounts that you contribute must be from wages earned as an employee (Form W-2), commissions, compensation received from self-employment (Form 1099-NEC and/or Form 1099-MISC), and/or taxable alimony. Income received from passive income sources such as interest, dividends and capital gains, pensions and retirement plan distributions, rental real estate, gifts and nontaxable alimony does not qualify as income sources that can be contributed into an IRA.

You can make contributions into an IRA at any time during the current year, and up through April 15th of the following year.

Tax Tip

The filing of an Extension does NOT extend the deadline for making contributions into an IRA for the current tax year beyond the April 15th deadline.

One provision of the SECURE Act of 2019 removed the age limit to make contributions into an IRA - as long as you continue to work.  Under prior law, the age at which one could make contributions into an IRA had been capped at age 70½.

There are two types of individually managed retirement savings plans:

  1. Traditional IRAs
  2. Roth IRAs

Withdrawals

You may withdraw funds from your retirement accounts, commonly known as “Distributions”, at any time.

Traditional Retirement Accounts (Pretax Contributions)

All Distributions received from your Traditional retirement accounts will be reported on a Form 1099-R for that tax year, with Code “7” recorded in Box 7 to indicate that these were normal distributions and must be included in your taxable income.

If you are under age 59½, such Distributions may also be subject to a 10% Federal early withdrawal penalty tax calculated on your Form 1040 tax return, unless such Distributions qualify for one of the IRS exceptions listed here:  https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions .  Generally, it is not prudent to take early Distributions from your retirement accounts, as these funds will no longer be invested to capitalize on The Power of Compounding.

You received a reduction in your taxable income in each of the years that you made such pretax contributions into your retirement accounts.  Once you begin to take Distributions from your Traditional retirement accounts, you will need to pay Federal and State income tax (Massachusetts residents only) on the amounts withdrawn.

Income Tax Withholdings

If you expect that your Distributions may be substantial (i.e., > $25,000 per year), it would be a good idea to speak with your retirement account fiduciary to have Federal income tax of 10%-15% (and for Massachusetts residents only, Massachusetts income tax of 5%) withheld from your Distributions to avoid receipt of an unexpected income tax bill in April.

Roth Retirement Accounts (After Tax Contributions)

You may withdraw the contributions that you made into your Roth IRAs, 401(k) and 401(b) retirement plan accounts at any time, for any reason, without incurring and income tax or penalties. This is because you made those contributions with after-tax dollars, so you've already paid income taxes on that money.  This is one of the key reasons why Roth retirement accounts make such good after-tax savings accounts for teenage children, and for that matter, for all of us.

All Distributions from your Roth retirement accounts will be reported on a Form 1099-R for that tax year, with Code “B” recorded in Box 7 to indicate that such distributions were received tax-free as qualified distributions from designated Roth accounts.

The IRS rules for withdrawing the earnings from Roth IRAs, 401(k) and 401(b) retirement plan accounts are different, however.  You may withdraw the earnings that were reported in your Roth IRAs, 401(k) and 401(b) retirement plan accounts at any time, if both of the following conditions are true:

  1. You are at least age 59½, and
  2. b.  It’s been at least five years since you first made contributions into any Roth IRA (the “Five-Year Rule”).

Any Roth earnings Distributions received if either of the above conditions are not met will be subject to the same 10% Federal early withdrawal penalty tax calculated on your Form 1040 tax return, as described under the Traditional Retirement Accounts (Pretax Contributions) section above.

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