How to Protect Your Retirement From the Taxman

As you file your taxes this year, there’s a simple way to stick it to the taxman…

This strategy is one of the most powerful ways to shelter your wealth from the IRS… grow money for retirement… and have freedom in your investment choices.

It’s a type of brokerage account called an individual retirement account, or “IRA.”

And while some folks get intimidated at the steps involved, think of it like opening any checking or savings account at your local bank.

In this issue of Retirement Millionaire Daily, I want to go over some basics of IRAs…

Who can open one?

Anyone who has earned income in the current year can open an IRA. You must have taxable income to be eligible.

IRAs are for individuals… spouses can’t be co-owners. If you file taxes jointly, each spouse can open an IRA even if only one earns income.

How much can you put in?

The maximum contribution to an IRA is $5,500 annually for an individual.

If you’re older than 50, you can contribute an extra $1,000 for a total of $6,500 (or $13,000 for a couple older than 50 using two IRAs). That extra benefit is so you can “catch up” in your final retirement-savings years.

How long do you have?

It’s important to note that you have until the due date for filing your tax returns to make a deposit to the previous year’s IRA. That means that most people will have until April 14, 2016 to make a contribution that will count in 2015.

If you’re contributing for the “prior” year, make sure to tell your plan sponsor (your broker or bank) that you want it to count for the prior year.

Now, everything that we’ve talked about so far applies to all IRAs… But there are two different types of accounts: a traditional IRA and a Roth IRA.

What’s the difference?

When you contribute to a traditional IRA, you’re contributing with pre-tax dollars. Your contributions to a traditional IRA can help lower your tax bill. And a traditional IRA doesn’t have limitations based on income.

Sometimes when you prepare your taxes, you’ll find you owe a small amount. You can often lower – or even eliminate – that tax liability by making an IRA contribution since you can make it count for the previous year. You’ll pay more into the IRA than you will on the tax bill, but at least you’ll be keeping the money for yourself instead of giving it to the taxman.

A traditional IRA also lets you compound your wealth from investments tax-free. You don’t pay taxes on capital gains, dividends, or interest payments until you start withdrawing from your IRA.

After 59 and a half, you can make withdrawals that the IRS taxes as ordinary income. For example, if you withdraw $50,000 a year, that will count toward your annual income. The IRS will tax you accordingly. And when you reach 70 and a half, you must start making withdrawals known as “minimum required distributions.”

If you’re older than 70 and a half, you can’t contribute to a traditional IRA. And you can’t withdraw your money until you reach 59 and a half years of age. If you do withdraw before then, you have to pay the taxes due, plus a 10% penalty.

A Roth IRA is sort of a flipped version of the traditional IRA. While you don’t get a tax break on your income when you contribute, you also don’t have to pay taxes when you make withdrawals from your future nest egg.

Unlike a traditional IRA, there are no age restrictions. But there are income restrictions… Individuals making more than $131,000 aren’t eligible to contribute to a Roth IRA in 2015. Next year, that limit goes up to $132,000. And a married person filing jointly can’t contribute if his or her household income is more than $183,000 in 2015, and $184,000 in 2016.

So how do you know which one to open?

A traditional IRA most benefits people who expect to be in a lower tax bracket when they have retired than when they are working.

A Roth IRA best works for people in the opposite situation. If you expect that your taxes will be higher as a retiree than as a working person, a Roth is perfect for you.

We often recommend opening both a traditional and a Roth IRA if you are unsure what your tax situation will be in your retirement. That way, you get the benefits of both methods.

Alternatively, a more advanced strategy is to convert a traditional IRA to a Roth. You won’t need to pay income taxes on subsequent withdrawals, but you will need to pay a lump-sum tax when you do the conversion. This can get tricky, so we recommend talking with your financial planner about all of your options.

Where should you open an IRA today?

Opening an IRA is as easy as opening any other brokerage account. You can do it with any brokerage. When registering, you simply select an IRA as the account type.

It’s as simple as that. And it will save you tens of thousands of dollars over just a decade or two of retirement savings.

If you’d like more information on the specifics of opening an IRA, I’ve put together a report called “Double Your Returns in Just One Hour a Year” exclusively for my Retirement Millionaire subscribers.

And if you’re not already a member, you can learn how to sign up by clicking here. (This link does not go to a long video.)

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