Article Highlights: Early Withdrawals Excess Contributions Multiple Rollovers No Traditional IRA Contributions in the Year Reaching age 70½ Failing to Take a Required Minimum Distribution (RMD) Late Contributions Switch the Type of IRA Backdoor Roth IRA Alimony as Compensation Spousal IRA Saver’s Credit IRA-to-Charity Direct Transfers There are both opportunities and pitfalls for IRA owners, and while you definitely don’t want to get caught up in a pitfall, you may want to take advantage of the opportunities. IRAs come in two varieties: the traditional and the Roth. The traditional generally provides a tax deduction for a contribution and tax-deferred accumulation, with distributions being taxable. On the other hand, there is no tax deduction for making a Roth contribution, but the distributions are tax-free. So, it leaves taxpayers with a significant decision, with long-term consequences of whether to contribute to traditional or Roth IRA. If you can afford to make the contributions without a tax deduction, then the Roth IRA is probably the better choice in most circumstances. However, some high-income restrictions limit the deductibility of a traditional IRA and the ability to contribute to a Roth IRA. Pitfalls – Here are some of the pitfalls that can be encountered with IRAs: Early withdrawals – IRAs were designed by the government to be retirement resources, and to deter individuals from tapping these accounts before retirement they added what is called an early withdrawal penalty of 10% of the taxable amount of the IRA distribution. The penalty generally applies for distributions made before reaching age 59-½, but there are some exceptions to the penalty. Excess contributions – The tax code sets the maximum amount that can be contributed to an IRA annually. Contributions in excess of those limits are subject to a nondeductible 6% excise tax penalty, and this penalty continues to apply each year until the over-contribution is corrected. Multiple rollovers – A rollover is where you take possession of the IRA funds for a period of time (up to 60 days) and then redeposit the funds into the same or another IRA. Only one IRA rollover is allowed in a 12-month period and all IRAs are treated as one for purposes of this rule. If more than one rollover is made in a 12-month period, the additional distributions are treated as taxable distributions and the rollover is treated as an excess contribution, with both causing significant tax and penalties. Rollovers can be avoided by directly transferring assets between IRA trustees. No Traditional IRA contributions in year reaching age 70½ - Individuals cannot make a Traditional IRA contribution in the year they reach the age 70½ or any year thereafter. This rule doesn’t apply to Roth IRAs. Contributions to a traditional IRA made in the year you turn 70½ (and for subsequent years) are treated as excess contributions and are subject to the nondeductible 6% excise tax penalty until corrected. Failing to take a required minimum distribution (RMD) – Individuals who have traditional IRA accounts must begin taking RMDs in the year they turn 70½ and in each year thereafter. However, the distribution for the year when an individual reaches age 70½ can be delayed to the next year without penalty if the distribution is made by April 1 of the next year. Failing to take a distribution is subject to a penalty equal to 50% of the RMD. The IRS will generally waive the penalty for non-willful failures to take the RMD, provided the individual has a valid excuse and the under-distribution is corrected. The RMD rules don’t apply to Roth IRAs while the owner is alive. Opportunities Late contributions – If you forgot to make an IRA contribution or just decided to do so for the prior year, the tax law allows you to make a retroactive contribution in the subsequent year, provided you do so before the unextended April filing due date. As an example, you can make an IRA contribution for 2018 through April 15, 2019. This is also a benefit for taxpayers who were not previously sure they could afford to make a contribution. Switch the type of IRA – If you make an IRA contribution for a year, tax law allows you to switch the designation of that contribution from a traditional IRA to a Roth IRA, or vice versa, provided you do so before the unextended April filing due date. Backdoor Roth IRA – Contributing to a Roth IRA is not allowed if the individual’s modified adjusted gross income (AGI) exceeds a specified amount based on filing status. For example, the limits for 2019 are $203,000 if filing a joint return, $10,000 if filing married separate, or $137,000 for all others. If a high-income taxpayer would like to contribute to a Roth IRA but cannot because of the income limitation, there is a work-around that will allow the high-income individual to fund a Roth IRA. Here is how that backdoor Roth IRA works: