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What is an IRA?
 by admin

November 28, 2021

Are you thinking about your retirement? Of course!  But it has a long way
to go.  Dear friend, you need to act and plan it now. The important thought
in this regard to consider is that, will you be able to generate the same
amount of money when you reach 60ies or less? Maybe, or may not be
sure? Then let’s plan it, in the most tax-e몭cient way. Your goal would be
to pay lower income taxes on your income in a long run at the same time
secure your future.

Individual Retirement tax saving plan

A retirement tax saving plan allows you to save income tax to the extent
of the amount you contribute to your retirement saving plan in the year
you contribute to the plan. In other words, your gross income for the tax
year is reduced by the amount you have contributed to your retirement
saving plan.

Although it is called a tax-saving plan in the year, you contribute, but in

reality, it is a tax deferral plan, unless it is a Roth IRA. When you
withdraw money, maybe later years or after you retire, the amount you
withdraw will be added to your income. You have to pay tax at that time
of withdrawal. This tax deferral helps you pay a minimum tax on your
income over the long run. Assuming you are in a high tax bracket right
now and when you get older or reach your retirement age, you will be in
a lower tax bracket. Please refer to tax brackets on the “Latest News”
page on our website for more information.
Of course, one of the signi몭cant bene몭ts is the tax deferral and
minimizing your overall income tax in the long run. However, there are
other bene몭ts as well. You can use this savings as a 몭rst-time
homebuyer. It promotes your saving habits. This saving also works as
your security deposit for any unforeseen 몭nancial stress you may come
across in your future.

There are limits to how much you can contribute to your retirement tax
saving plans in a year. In this blog, we are going to discuss more on the
retirement tax saving plans in the United States. In Canada, this plan is
called the “RRSP” Registered retirement saving plan, and in the United
States, it is called the “IRA” individual retirement plan. Please visit our
blog “RRSP Tax Planning” for more details on the Canadian registered
retirement savings plan.

Individual Retirement Account (IRA) in the United States

IRA is the same as we discussed above “retirement tax saving plan” in

the United States. There are basically two types of IRS.
Traditional IRA

A Traditional IRA is called a Tax-deferred retirement savings account.

Under this plan, you invest your pre-tax money in IRA. The amount you
contribute to IRA reduces your income for that year, and you pay lower
income tax on a lower income.

Roth IRA

A Roth IRA is called a Tax-free retirement savings account. Under this

plan, you invest your after-tax money in IRA.

Tradition Vs. Roth IRA

You invest your pre-tax money into Tradition IRA while you
invest your after-tax money into Roth IRA.
Your contribution to Traditional IRA reduces your taxable
income, while your investment into Roth IRA does not.
Withdrawals from Traditional IRA are taxable when you
withdraw, including any gain/income on the investment.
Withdrawals from Roth IRA are not taxable when you
withdraw, including any gain/income on the investment.
To be eligible to invest in Roth IRA, an income threshold
applies while there is no such income threshold for Traditional
IRA.
 There is a minimum distribution requirement for Traditional
IRA, which starts at the age of 72, while no such minimum
requirement for Roth IRA.

The bene몭t of a 401k plan

Under the traditional plan, the amounts contributed by you are not
taxable. For example, your employer has agreed to pay you gross wages
of 100k/year.  Assuming you want to contribute $6k/year to your IRA
plan. On your tax return for the year, you will only pay income tax on your
wages of $94k i.e. $100k minus your contribution of $6k. You saved an
income tax of $6k. You did not pay income tax on $6k that went to your
retirement investment. Now, you will invest your $6k retirement to the
stocks/몭nancial market, and the income or gains on this investment will
also not be taxable.

Your principal investments and any income or gains on this investment

will only be taxable in the year you withdraw and you have to pay income
tax at that time.

So the real tax savings is from the tax deferral. Assuming that today you
are paying 30%  tax on your income. You are above the base level tax
bracket. When you retire your tax bracket might be 15% and hence you
will save 15%(30% – 15%) income tax on your $6k investment plus on
any income or gain. Please visit our “Latest News” for tax brackets.

Contribution limit

Under both the above plans, up to the age of 50, you can contribute to
your IRA $6,000 every year if you are older than 50. Your limit to
contribute increases to $7,000 every year.

Penalty for withdrawal

Under both the above plans, if you withdraw before the age of 59.5
years, a penalty will apply.

While discussing your retirement savings and tax deferral options you
must have come across another term called “401(k) plans. Please visit
our other blog “401k” for more information about this plan.

Disclaimer: Information in the blog/post/article has been presented for a broad and simple

understanding. This is not legal advice. RKB Accounting & Tax Services does not accept any liability

for its application in any real situations. You need to contact your accountant or us for further

information

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