How Fixed Index Annuities Can Help
When helping clients daily, it's helpful to know the options that can aide them in choosing a product that works for their financial situation. While a Traditional IRA or Roth IRA can be opened for anyone with working income, a Fixed Index Annuity could be used as well. Someone age 18 contributing $7,000 per year could have close to $3 million saved by age 68 with a Fixed Index Annuity. Talk about a big plan! See the attached hypothetical and then contact UMS to see how opening an IRA at a young age could possibly generate over $3 million in retirement assets.
Let's Start at the Beginning with Traditional IRA Tax Basics
To save you the trouble of looking it up, for the 2023 tax year, a traditional IRA contribution of up $6,500 (or the amount of your earned income, if that amount is less) is possible. Earned income generally means income from wages or self-employment. For the 2024 tax year, the maximum IRA contribution is raised to $7,000.
If married and filing a joint return, your client and their spouse can each contribute up to $6,500 for 2023 ($7,000 for 2024) if together they have enough combined earned income to cover their combined contributions. If only one spouse has earned income, that income can be used to cover that spouse’s contribution and a contribution by the spouse without earned income.
For your younger clients, there are some advantages of traditional IRAs. First, traditional IRA contributions are potentially deductible. This depends on a number of factors from filing status, income, tax-favored retirement plan (401k) through employment, self employed plans, etc. For example, a single person, participating in a tax-favored retirement plan, there is a point where contributions are phased out (typically between $73,000 - $83,000). But for 2024, that number is $77,000 - $87,000 for single individuals. If they are single and do not participate in an employer plan, no phase-out rule applies. Married, joint-filers both participating in tax-favored retirement plans have a higher phase out at $116,000 - $136,000 for 2023 and $123,000 - $143,000 for 2024. Lower tax brackets have a lower deductibility advantage. Consult a tax advisor for more details.
There are also some tax disadvantages of traditional IRAs that cannot be left out. Withdrawals from traditional IRA are taxable to the extent they consist of deductible contributions and account earnings. Also, withdrawals taken before age 59½ will receive a 10% early withdrawal penalty unless an exception applies. For example, young adults can take withdrawals to cover qualified higher education expenses or first-time home purchases.
Traditional IRAs are also subject to Required Minimum Distribution (RMD) rules that require withdrawals after age 73 (2024), resulting in income tax.
What about Roth IRA?
For the 2023 tax year, clients can make a Roth IRA contribution of up to $6,500 (or the amount of your earned income, if less). For 2024, the maximum Roth contribution is raised to $7,000.
If married, their spouse can also make a Roth contribution of up to $6,500 (for 2023; $7,000 for 2024) if they and their spouse have enough combined earned income to cover their combined contributions. If only one spouse has earned income, it can be used to cover that spouse’s contribution and a contribution by the spouse without earned income.
What are the advantages of a Roth IRA when it comes to taxes? First, qualified distributions from a Roth IRA are federal income-tax-free and often state income-tax-free as well. Qualified distributions can be taken once the account owner reaches age 59½ and has had at least one Roth IRA open for 5+ years. We know taxes will most likely be higher in the future. This may be appealing to young people if they expect to be in a higher tax bracket during retirement. Obviously, we cannot predict the future, but it is reasonable to assume that tax rates will be higher for those living a comfortable retirement (which is the goal!) and therefore taxes will be higher. Another advantage when it comes to a Roth IRA is the tax-free and penalty-free distributions up to a cumulative amount of the annual contributions. While it's best to leave a Roth account balance untouched and continue to accumulate earnings that could be withdrawn tax-free eventually, it's nice to know that these tax-free and penalty-free Roth withdrawals are an option if needed.
What's more, is that Roth accounts are exempt from RMD rules for as long as the account owner lives. So, if that money is untouched in retirement, they can leave that account to heirs who will usually be able to take tax-free qualified Roth withdrawals after they are gone.
BONUS! With Roth IRA, the ability to make annual contributions is unaffected even if they participate in a tax-favored company or self-employed retirement plan.
There are some tax disadvantages as well. For starters, Roth contributions are not deductible. If current tax savings are needed, a traditional IRA may be the better option, but ensure that the contributions will be deductible. Consult a tax advisor for which option suits your client's situation effectively.
There are also income restrictions on making annual Roth IRA contributions. For 2023, once a single, unmarried individual reaches an adjusted gross income of $138,000 - $153,000, the ability to contribute is phased out. And for a married, joint-filer, it is an adjusted gross income of $218,000 and $228,000. For 2024, those numbers for single, unmarried is $146,000 - $161,000. For married, joint filer, it is $230,000 - $240,000.
When we are discussing young adults, these income restrictions are often not an issue and modest IRA contributions beginning at a young age can mean potentially large amounts by retirement. If a 22-year old were to contribute $2,000 to a Roth IRA at the end of each year, by the time they are 60 years old (assuming a 5% annual rate of return), the Roth account could be worth about $215,000. So, $2,000 per year over 38 years would be $76,000 in contributions and the rest would be potential accumulation. Many will choose to raise their contributions as they get older. Once they begin working, they could raise their contributions to $5,000. So, let's say they contribute $2,000 for 10 years beginning at age 22 like before, but at age 32, they begin contributing $5,000 until they reach age 60. Assuming the same 5% annual rate of return, they could have an account potentially worth $390,000 at that time. These of course, are just examples and depends on a variety of factors. With manageable annual contributions, starting at young ages, an IRA could reach great amounts by the time people approach retirement age.
Ultimately, making traditional IRA contributions may the best choice if contributions will be deductible and they need the resulting tax savings. Making Roth IRA contributions may be the best choice if clients don't need current tax savings from their contributions and they expect to be in a higher tax bracket during retirement than they are right now. Generally, the more affluent they expect to be, the better the Roth IRA option looks. If their income is too high to make deductible traditional IRA contributions AND too high to make Roth IRA contributions, they can always make nonduductible traditional IRA contributions no matter how high their income. If they already have money in one or more traditional IRAs, they could consider conversion into a Roth IRA. There would of course be a tax cost for that conversion. Something else to consider, is assuming they are within income limits, they could make traditional or Roth IRA contributions in addition to contributions to a company or self-employed retirement plan.
So there you have it! There are many options to choose from when clients are planning for their futures. As with anything regarding financial planning, discuss all of this with an investment advisor. We are here to educate, but do not give any tax advice or planning advice. A financial advisor can look at an individual's financial situation and help review their IRA options to decide on strategy to fit current circumstances and expectations for retirement.
Converting an employer plan account to a Roth IRA is a taxable event. Increased taxable income from the Roth IRA conversion may have several consequences including (but not limited to) a need for additional tax withholding or estimated tax payments, the loss of
certain tax deductions and credits, and higher taxes on Social Security benefits and higher Medicare premiums. Be sure to consult with a qualified tax advisor before making any decisions regarding your IRA.
The hypothetical investment results are for illustrative purposes only and should not be
deemed a representation of past or future results. Actual investment results may be more or less that those shown. This illustration does not represent any specific product and/or service.
This document is designed to provide general information on the subjects covered. It is not, however, intended to provide specific legal or tax advice and cannot be used to avoid tax penalties or to promote, market, or recommend any tax plan or arrangement. Please note that Underwriters Marketing Service, its affiliated companies, and their representatives and employees do not give legal or tax advice. Encourage your clients to consult their tax advisor or attorney.