The two different types of individual retirement accounts that are widely utilized are the traditional IRA and the Roth individual retirement account. There are similarities between them, but there is one major difference, and we look at the details in this post.
Traditional Account Rules
You make contributions into a traditional account before you pay taxes on the earnings. This is beneficial in the near term, because the contributions reduce your taxable income.
On the flipside, distributions from the account are subject to taxation. Since the IRS wants to start getting some money eventually, you are have to take required distributions (RMDs) when you are 72 years of age.
The RMD age went up to 72 as a result of the enactment of the SECURE Act at the end of 2019. In the past, it was 70.5, and there is another change that allows a traditional account holder to contribute into the account indefinitely.
You can start to take penalty-free voluntary distributions when you are as young as 59.5 years old, but there are a few exceptions. Up to $10,000 can be withdrawn to help with a first home purchase, and assets in the account can be used to pay medical bills and school tuition.
Roth Individual Retirement Accounts
Roth IRAs are funded with after-tax earnings, so distributions are not taxed. Everything is the same with regard to the age at which you can take penalty free withdrawals, and you can contribute into the account for any length of time.
You are never required to take distributions from a Roth individual retirement account, and this is beneficial from an estate planning perspective if you do not need the money.
Guidelines for IRA Beneficiaries
A spouse that inherits an individual retirement account can retitle the account as an inherited account or roll it over into their own personal IRA.
Non-spouse beneficiaries do not have the rollover option. They must take required minimum distributions each year. Roth account beneficiaries do not have to claim the income when they file their taxes, but distributions to traditional account beneficiaries are taxable.
There was a very effective estate planning strategy that was commonly utilized called the “stretch IRA” that is no longer available. Prior to the enactment of the SECURE Act, beneficiaries could take only the minimum that was required by law for any period of time.
This would give the beneficiaries of well-funded accounts the opportunity to stretch them out to maximize the tax benefits. The stretch IRA was particularly useful for Roth account beneficiaries because of the tax-free distributions.
Now, inherited individual retirement accounts must be emptied out and closed within 10 years of the time of acquisition.
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Mr. Nirenstein is licensed to practice before the courts of the State of Connecticut and the United States District Court. He is a member of the Connecticut and Hartford County Bar Associations, and the Estate and Probate, Elder Law, Business Law and Real Estate Sections of the Connecticut Bar Association.
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