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Retirement Perspectives

With increasing lifespans and longer time spent in the workforce, eligible investors may want to explore this option, especially when it comes to legacy planning.

Are you too old to open a Roth IRA?  While these retirement accounts typically are marketed to younger savers in lower tax brackets, there is no age limit on contributing to Roth IRAs, unlike traditional IRAs, in which the age limit is the year one turns age 70½.

As long as you have earned income and satisfy an IRS-mandated income test, you can fund a Roth IRA. Sure, you have to pay the taxes on such contributions up front, but there’s no guarantee that taxes won’t be higher as you get older; and thanks to modern medicine, life expectancies generally are on the rise.

In addition, there’s the potential to pass Roth IRAs on to your heirs tax-free. By combining a Roth with a “stretch” strategy, a benefactor may be able to extend the tax-free status of the Roth IRA assets across multiple generations.

Roth Rules
Roths differ from traditional IRAs, in that Roth accounts that are inherited by a surviving spouse are not subject to lifetime required minimum distributions (RMDs) for the account owner and surviving spouse, whereas all traditional IRAs are subject to RMDs, regardless of who inherits. A surviving spouse who inherits a Roth IRA could opt not to touch the account, letting it grow and accumulate assets for subsequent generations.

The power of a Roth IRA is that the earnings grow tax-deferred, and withdrawals are tax-free, as long as the account has been opened for five years and the account owner is at least 59½ years old, or disabled, or dies (in which case, the heirs’ withdrawals are generally tax-free).

Remember: If you are retired, but still have earned income (e.g., part-time work, self-employment, etc.), you may be eligible to fund a Roth IRA and you may take tax-free withdrawals of basis at any time.

In other words, Roth IRAs may offer more flexibility when it comes to taxes and/or unexpected expenses, such as medical costs. Still, estate and legacy planning are one of the most common reasons older individuals contribute (or convert) to Roths. Think tax-free inheritance.  

When a child or grandchild inherits a Roth IRA, generally the account proceeds can be “stretched” out over the life expectancy of the beneficiary. However, the non-spouse beneficiary must begin taking distributions no later than the year following the account owner’s death. While a spousal beneficiary has more flexibility, the surviving spouse, in this scenario, can choose to remain a beneficiary or can make the Roth IRA his or her own, continuing to defer RMDs.

How It Works
For example, Ted, 73, works part-time, earning $8,000 annually selling widgets. Ted contributes $6,500 to a Roth IRA, without being required to take a minimum distribution. When Ted dies at age 80, his Roth IRA is bequeathed to Rose, his surviving spouse. Rose, too, as a spousal beneficiary, is not required to take RMDs either, although both she and Ted, while living, could take a withdrawal at any time.

Rose also could fund her own Roth IRA annually, assuming she has earned income, or Ted (while he was alive) could fund a separate Roth in her name, according to spousal IRA rules. Such an approach may effectively double the amount of money a couple can save for their heirs.

When Rose passes, she leaves her Roth account to her 20-year-old granddaughter, Jill. Distributions to Jill are generally tax-free. Jill now has the option of “stretching” tax-free payments based on her life expectancy (63 years, according to IRS actuarial tables). In other words, Jill’s grandparents have given Jill “the gift that keeps on giving”: potentially tax-free income. 

The ability to pass on the exemption from RMDs, along with the assets, applies only to spousal beneficiaries. Non-spouse beneficiaries who inherit Roth IRAs are required to take minimum distributions in the year following the death of the account owner, regardless of the beneficiaries’ ages. But they can stretch the distributions over the life expectancy of the beneficiary or, in the case of multiple heirs, the life expectancy of the oldest one.

If you have any questions about this or another retirement topic, please e-mail me at roadtoretirement@lordabbett.com.

 

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

A SIMPLE IRA plan is an IRA-based plan that gives small-business employers a simplified method to make contributions toward their employees’ retirement and their own retirement. Under a SIMPLE IRA plan, employees may choose to make salary reduction contributions and the employer makes matching or nonelective contributions. All contributions are made directly to an individual retirement account (IRA) set up for each employee (a SIMPLE IRA). SIMPLE IRA plans are maintained on a calendar-year basis.

A simplified employee pension plan (SEP IRA) is a retirement plan specifically designed for self-employed people and small-business owners. When establishing a SEP-IRA plan for your business, you and any eligible employees establish your own separate SEP-IRA; employer contributions are then made into each eligible employee’s SEP IRA.

401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an aftertax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.

A 403(b) plan is a retirement savings plan that allows employees of public schools, nonprofit, and 501(c)(3) tax-exempt organizations to invest on a pretax and or Roth aftertax basis. Contributions to a 403(b) plan are conveniently deducted directly from your paycheck. In addition, your employer may elect to make a contribution on your behalf.

A Stretch IRA is for investors who will not need their IRA money during their own retirement. While the law does not restrict which tax payers can select the stretch IRA option, the stretch strategy is appropriate only for those individuals who simply need and plan to receive the required minimum withdrawals, taken at the latest time the law allows, without penalty, age 70½.

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