By David N. Chazin
With so much media attention spotlighting retirement planning these days, you’d think the United States is a nation of hardcore investors, well-versed in the intricacies of all sorts of financial products. But the truth is most Americans know relatively little about one of the most effective tools for securing their financial futures: the Individual Retirement Account (IRA).
Indeed, over 50% of Americans don’t even have an IRA, according to Reuters. That may be due in part to a lack of understanding about what an IRA is and how you can use it to help you achieve your financial goals.
Opening up an IRA account enables you and your fellow lab employees to take advantage of many different investment products, including mutual funds, stocks, bonds, exchange-traded funds and REITs. Virtually any security that can be owned outside an IRA, can be owned inside an IRA. The main advantage is that like your 401(k), 403(b) retirement plans and other UC accounts, there is a tax advantage to investing inside an IRA vs. outside an IRA.
This is important to understand because it gives investors the flexibility and latitude to help reach their financial goals, whether they’re short-term or long-term. Knowing how to use an IRA effectively should be the goal of any investor.
Traditional vs. Roth IRAs
You should take some time to understand the difference between a traditional and a Roth IRA. In short, contributions to Roth IRAs are made with after tax dollars and qualified withdrawals are tax free. By contrast, contributions to traditional IRAs may be tax-deductible, but withdrawals are taxed as ordinary income. Your Adjusted Gross Income and participation in your 401(k) retirement plan will determine if a traditional IRA is deductible.
In addition, your Adjusted Gross Income will determine if you can contribute to a Roth IRA. You can always contribute to a non-deductible traditional IRA if you do not qualify for a Roth or a deductible traditional IRA. IRA withdrawals from a traditional IRA if taken prior to age 59 ½, may be subject to an additional 10% federal tax penalty and possibly state income taxes. Qualified distributions of earnings from a Roth IRA are tax-exempt after five years from the contribution date and after age 59 ½. Earnings taken prior to age 59 ½ may be subject to a 10% federal tax penalty and possibly state income taxes.
This is an important distinction because it can guide your decision about which IRA to invest in. In general, traditional IRAs are beneficial for people who expect to be in a lower tax bracket when they retire, since they pay the taxes when they withdraw the money. Roth IRAs typically make sense for people who believe they’ll be in a higher tax bracket someday. You’ll be able to pay the tax earlier in life and then reap the benefits of its potential tax-free growth. It’s also important to note that traditional IRAs have required minimum distributions starting at age 70 ½, while Roth IRAs do not.
Regardless of whether it’s Roth or traditional, a major benefit of an IRA is that you can fill it with just about any type of investment product. In other words, you can find the investment vehicles that match your goals and risk tolerance, from a long-term aggressive to short-term and cautious. Certainly, a mixture of mutual funds, stocks and bonds within an IRA can help achieve the sort of diversity that most investors seek.
Making the most of an IRA can also mean managing an inherited one appropriately. Indeed, mishandling an inherited IRA is a common-and expensive-mistake. If you are the beneficiary of an IRA, it is important to get competent advice before receiving the money.
Proper titling is crucial, because if you do it incorrectly you (as the beneficiary) may have to distribute the IRA in five years. But if the IRA is titled correctly, you can receive distributions over your lifetime. For example, a custodian may require that an account be titled as follows if it involves a father, John Jones, who dies and leaves an IRA to his son, Sam: John Jones, deceased (date of death), IRA for the benefit of Sam Jones. Titling the account properly enables Sam to take distributions over his lifetime, which can potentially add a lot of value to an IRA by allowing additional growth potential over many years.
Some lab employees may not have an IRA, so one way to establish one is by rolling over your UC accounts (403(b), 457, or DCP) or an old 401(k) retirement plan into an IRA. This would give you the investment flexibility described above, instead of being limited to just the funds offered by UC or your old 401(k) retirement plan. (This is because you have a separation of service from UC, but you cannot rollover your current LLNS 401(k) retirement plan.) You might consider talking to a third-party financial planner who allows you to choose from a considerably larger selection of different investment vehicles.
Because I work with many lab employees and retirees, I’m very knowledgeable about the UCRP, UC’s retirement accounts, the options available with TCP2, plus other issues specific to lab employees (in addition to the retirement, investment, and estate planning issues everybody faces). In fact, chances are you may know one of my lab clients and you can ask them how working with an advisor has helped them.
I’d also be happy to sit down with you to review your current situation, answer any financial questions you have, examine issues specific to you (such as which IRA makes more sense or an in-depth retirement plan) and discuss a strategy for your retirement or investments.
Please contact us at (800) 318-7848 with specific questions or to schedule a time to meet in either our San Ramon or Livermore office (about a mile from the lab).
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