Individual Retirement Accounts (IRAs) – Maximize Your Tax Benefits

Individual Retirement Accounts (IRAs) are tax-advantaged savings vehicles designed to help individuals accumulate funds for retirement. The two primary types are Traditional IRAs and Roth IRAs. Both offer unique tax benefits and play important roles in retirement and estate planning.

1. Tax Benefits

Traditional IRA:

• Tax Deduction: Contributions may be deductible, depending on your income and participation in an employer-sponsored retirement plan.
• Tax-Deferred Growth: Earnings grow tax-deferred; taxes are paid upon withdrawal.
• Taxation of Distributions: Distributions are taxed as ordinary income. If you made nondeductible contributions, a portion of each withdrawal is tax-free.

Roth IRA:

• No Upfront Deduction: Contributions are not deductible.
• Tax-Free Growth: Earnings grow tax-free.
• Tax-Free Qualified Distributions: Withdrawals are tax-free if the account has been open at least five years and you are age 59½ or older, or meet other qualifying criteria (death, disability, or first-time home purchase up to $10,000).

Health Savings Accounts (HSAs):

• While not an IRA, HSAs are another tax-advantaged vehicle for those with high-deductible health plans. Contributions are deductible, grow tax-free, and qualified withdrawals are tax-free.

2. Estate Planning Benefits

Beneficiary Designations: IRAs pass directly to named beneficiaries, bypassing probate.

Stretch IRA: Non-spouse beneficiaries must generally withdraw the entire account within 10 years of the original owner’s death, but certain “eligible designated beneficiaries” (e.g., surviving spouses, minor children, disabled individuals) may use life expectancy payout rules.

No Step-Up in Basis: Unlike taxable accounts, IRAs do not receive a step-up in basis at death; distributions to beneficiaries are generally taxable as ordinary income.

3. Income Thresholds and Contribution Limits (2025)

Annual Contribution Limits (2025):

• Traditional and Roth IRAs: $7,000 per person under age 50; $8,000 if age 50 or older (includes $1,000 catch-up).
• Deadline: Contributions for 2025 must be made by April 15, 2026.

Traditional IRA Deductibility Phase-Outs (2025):

• Single/Head of Household (covered by work plan): Deduction phases out between $79,000 and $89,000 MAGI.
• Married Filing Jointly (covered by work plan): $126,000–$146,000 MAGI.
• Married Filing Jointly (spouse covered): $236,000–$246,000 MAGI.
• Married Filing Separately: $0–$10,000 MAGI.

Roth IRA Contribution Phase-Outs (2025):

• Single/Head of Household: $150,000–$165,000 MAGI.
• Married Filing Jointly: $236,000–$246,000 MAGI.
• Married Filing Separately: $0–$10,000 MAGI.

4. Backdoor and Mega Backdoor Roth IRAs

Backdoor Roth IRA:

For high-income earners ineligible to contribute directly to a Roth IRA, a “backdoor” Roth involves making a nondeductible contribution to a Traditional IRA and then converting it to a Roth IRA. The conversion is taxable to the extent of pre-tax amounts in all IRAs, so the pro-rata rule applies.

Mega Backdoor Roth IRA:

This strategy uses after-tax contributions to a 401(k) plan (if allowed by the employer) and then rolling those funds into a Roth IRA or Roth 401(k). This allows for much larger Roth contributions than the standard IRA limits, but is only available in certain employer plans.

5. Recent and Upcoming Changes

Recent Changes:

• SECURE 2.0 Act: Introduced new exceptions to the 10% early withdrawal penalty, including for domestic abuse victims (up to $10,000 or 50% of the account), emergency personal expenses (up to $1,000 per year), and federally declared disasters (up to $22,000).
• RMD Age Increase: Required Minimum Distributions (RMDs) now begin at age 73 for those turning 73 in 2025. Roth IRAs remain exempt from lifetime RMDs.
• Catch-Up Contributions: For 2025, catch-up contributions for those age 50+ remain at $1,000 for IRAs, but higher catch-up limits apply to certain employer plans for those ages 60–63.

Upcoming Changes (2025 and Beyond):

• Roth Catch-Up Contributions: Starting in 2026, catch-up contributions to employer plans must be made as Roth contributions for employees earning over $145,000 (indexed for inflation).
• Annual Contribution Limit Adjustments: IRA and employer plan contribution limits are indexed for inflation and may increase in future years.

6. Strategic Considerations

• Prioritize employer plan contributions to maximize any employer match, then fund an HSA if eligible, then contribute to a Roth IRA or deductible Traditional IRA if eligible.
• If ineligible for deductible or Roth IRA contributions, consider a backdoor Roth IRA.
• Nondeductible Traditional IRAs may be preferable to taxable accounts for tax-inefficient investments and long holding periods, but taxable accounts may be better for tax-efficient investments and shorter time horizons.

IRAs remain a cornerstone of retirement and estate planning. Understanding the tax benefits, contribution limits, income thresholds, and recent legislative changes is essential for optimizing your retirement strategy. Please let us know if you would like a personalized analysis or have questions about implementing any of these strategies.