Maximizing Retirement Savings: Benefits of IRAs

By: Caitlyn Farrington

Key Takeaways:

Choosing the Right IRA: Traditional, Roth, SIMPLE, and Custodial IRAs offer different tax benefits and rules. Traditional IRAs provide tax-deferred growth, while Roth IRAs offer tax-free withdrawals, making it crucial to choose based on your retirement goals and tax situation.
Maximizing Contributions: For 2024, IRA contributions are capped at $7,000 ($8,000 for 50+). High earners can use strategies like backdoor Roth conversions to take advantage of tax-free growth.
Qualified Charitable Distributions (QCDs): QCDs allow tax-free donations from IRAs to charities, lowering taxable income. Stay updated on rule changes, like increased RMD ages, to optimize retirement planning.

Taking advantage of your employer-sponsored retirement plan is a recommended tool to fund and plan for your retirement. However, the individual retirement plan (IRA) is also a viable option, especially when you consider the numerous tax benefits IRAs offer. Let us walk through the various classifications of IRAs, determine which is right for you and your family, as well as familiarize ourselves with the current rules and regulations regarding income limits, age restrictions, and allowable contribution amounts.

Traditional IRA

The most popular IRA option is the traditional IRA, which allows your earnings to grow tax-deferred over time. Your current year contributions are tax-deductible in the year of contribution, if you qualify. There are no income limitations to contributing to a traditional IRA, making this classification advantageous for those who currently sit in a higher tax bracket than they expect to be in during retirement. For the 2024 tax year, the traditional IRA contribution limit has increased to $7,000 ($8,000 for 50 years old and up). There are limitations on deducting a contribution to a traditional IRA if you are covered by an employer-sponsored retirement plan. The amount deductible is determined by the taxpayer’s filing status, amount of modified AGI, and coverage status (if married).

Distributions from a traditional IRA are includible in taxable income in the year taken, regardless of age. If, however, you are under 59.5 years old, an additional 10% penalty may apply. There are exceptions to this penalty, some of which are listed below:

First-time home purchase, up to $10,000
Education expenses
Disability or death
Medical expenses
Birth or adoption expenses

One of the benefits of owning a traditional IRA is the ability to complete a Qualified Charitable Distribution (QCD). The QCD allows the withdrawal from the IRA to be made directly to an eligible charitable organization of your choosing. This distribution is not taxed or included in taxable income. Moreover, it lowers your adjusted gross income and is not subject to withholding. QCDs are permitted as part of the required minimum distributions (RMD) requirements if the donation is made by the RMD deadline. There is a 25% excise tax (reduced from 50% in 2022) on insufficient or late RMD withdrawals. In 2024, individuals who are 70.5 years old and up can donate up to $105,000 ($210,000 if married filing jointly if spouse also has an IRA).

Before getting too excited about QCDs there are a few guidelines and restrictions to keep in mind. You may not withdraw the donation yourself and then contribute to the qualified charitable organization. The donation must come from the IRA custodian directly to the charitable organization. QCDs may also not be used as donations to donor advised funds, private foundations, or supporting organizations. Lastly, the same type of acknowledgment from the receiving charitable organization that you receive with a normal donation is also required when QCDs are utilized.

President Biden signed a bill at the end of 2022 that contained retirement modifications as well as changes to the QCD rules for 2023 and after:

Increase in QCD limit: Effective for years after 2023, the QCD limit will be adjusted for inflation (the 2024 limit is $105,000).
Increase in IRA RMD age: Effective on 1/1/23, the age for RMD is increased to 73. Additionally, the age for RMDs changes to 75 on 1/1/33.
One-time split interest election: This allows a donor to make a QCD of up to $53,000 in 2024 to fund one of the following. The limit will be adjusted for inflation annually.

- Charitable Remainder Unitrust (CRUT)
- Charitable Remainder Annuity Trust (CRAT)
- Charitable Gift Annuity (CGA)

Roth IRA

The second most popular IRA classification is the Roth IRA. Roth IRAs are like traditional IRAs in many aspects. However, how they are taxed tends to be the largest distinction. This retirement vehicle allows after-tax contributions where both the contribution and the earnings on those contributions grow tax-free over time. While current year contributions are not tax-deductible on your tax return, withdrawals are completely tax-free after the age of 59.5 if the account has been open for at least five years. Unlike a traditional IRA, there are no required minimum distributions (RMDs), and you can continue making contributions even after 70.5 years of age. Roth IRAs are advantageous for individuals who expect to be in a higher tax bracket when withdrawals begin.

Roth IRAs come with several eligibility requirements. If your filing status is single, to contribute in 2024, your modified adjusted gross income (MAGI) must be under $161,000 ($240,000 for married filing jointly). The income phase-out ranges begin at $146,000 for single filers and $230,000 for married filing jointly. This means you can still contribute, but your contribution will be reduced or “phased out” until the upper limits are reached. Same as with a traditional IRA, the maximum contribution you can make to a Roth in 2024 is $7,000 annually ($8,000 if you are age 50 or older).

If you find yourself unable to participate in a Roth IRA due to the income limitations, there is a legal tax strategy to explore. The backdoor Roth IRA conversion allows high-income earners who are normally ineligible to contribute directly to a Roth IRA to still reap the benefits that Roth IRAs offer. Rather than contribute to a Roth, you first contribute to a traditional IRA and then convert it into a Roth. These conversions are considered rollovers and provide a huge tax planning opportunity. A backdoor Roth conversion is a taxable event in the year it is completed, just like taking a distribution from your traditional IRA would be. The taxpayer is likely to have basis in the traditional IRA contribution, so the entire distribution may not be taxable (it is possible that only earnings on original contribution are taxable). Lastly, if you elect to do a backdoor Roth conversion, you must wait five years to tap into that portion you converted.

There are three ways to complete a backdoor Roth conversion:

Rollover – receive a traditional IRA distribution; then contribute that to a Roth within 60 days.
Trustee to trustee transfer – traditional IRA trustee to Roth IRA trustee.
Same trustee transfer – can be done by simply redesigning the account.

SIMPLE IRAs

Another type of individual retirement account is the Savings Incentive Match Plan for Employees (SIMPLE) IRAs. This option can be advantageous for sole proprietors and small business owners with fewer than 100 employees. SIMPLE IRAs are easy to set up and administer, have lower costs than 401(k) plans, and have higher contribution limits than traditional IRAs. In 2024, participants can contribute up to $16,000 for the year ($19,500 for age 50 and up).

Custodial (Minor) IRA

Children under 18 years of age are eligible to open an IRA account if the child is actively receiving earned income. The account setup can be either a Traditional or Roth IRA. This can be advantageous for parents who own a Sole Proprietorship or a Single Member LLC business. If legitimate work is being performed, a parent can hire their minor child tax-free and pay them up to $14,600 for the 2024 tax year. These funds, up to the annual contribution maximum (discussed above), can then be funneled into the custodial IRA. These funds may be used for future expenses such as college tuition, down payment on a home, or retirement.

Choosing the Right IRA: Tax Benefits for Your Retirement Strategy

There are several tax benefits to owning an individual retirement account (IRA) to fund your retirement. Several different types of IRAs exist that could be beneficial to you and your family depending on your individual tax situation. These include traditional IRAs, Roth IRAs, SIMPLE IRAs. In general, if you expect to be in a higher income tax bracket upon retirement, the Roth IRA is right for you as contributions are not deductible, but withdrawals are tax-free. Conversely, if you expect to be in a lower tax bracket upon retirement, the traditional IRA may be your best option. With a traditional IRA, contributions are deductible, but distributions are taxed upon withdrawal. Care should be taken when determining which option is best for you.

Reach Out to Your Tax Advisor

Secure retirement depends on planning sooner rather than later. Individuals are encouraged to seek assistance from experienced tax professionals to listen to your specific tax situation and needs and determine what option is right for you. Whether you are trying to fund your retirement while also putting children in college or determining how best to reduce your lifetime tax liability while also contributing to charities, IRAs should be prioritized as a retirement option.

Content provided by Caitlyn Farrington, LBMC Tax Manager. She can be reached at caitlyn.farrington@lbmc.com.

LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.

Traditional IRA

Roth IRA

SIMPLE IRAs

Custodial (Minor) IRA

Choosing the Right IRA: Tax Benefits for Your Retirement Strategy

Reach Out to Your Tax Advisor

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