In 1974, a remarkable set of legislation called ERISA was passed that completely overhauled America’s pension and retirement framework. One of the more transformative components of ERISA has turned out to be the IRA, a financial retirement backbone for millions of Americans that grows in importance every year as old-fashioned pension plans quickly disappear.
As popular as IRAs might be, however, there are still little-known features within them that can prove to be abundantly useful if used under proper circumstances. Although these tips might not apply to everyone, every IRA owner is better off at least knowing that they are available if the need arises.
Much of the consternation involved in using an IRA is choosing between a traditional and a Roth. While it’s perfectly legal to own and contribute to both, most people tend to choose one or the other according to their income tax brackets. The good news, however, is that even if you’ve elected to use a traditional IRA to take advantage of pretax contributions, that doesn’t necessarily mean that you’re locked into it forever.
With a Roth conversion, the IRS allows you to convert a pretax, traditional IRA to a Roth IRA. Of course, this involves paying taxes on the balance but doesn’t include any sort of early distribution penalty. For instance, if you have been paying into a traditional IRA for years and suddenly experience a temporary but significant fall in income, your subsequent drop in tax brackets may provide a great opportunity to convert that traditional IRA into a Roth, therefore paying lower taxes on it then you would have otherwise. From there on out, even if you start contributing to that Roth IRA in the future, distributions will be taken tax-free in retirement.
First Time Home Buyers
Another infrequently used provision within IRAs is the penalty free distribution allowed for first time home buyers. In fact, the provision is even more flexible than it appears at first glance. Under these circumstances, a first-time homebuyer is defined as anyone that hasn’t owned a home or had financial interest in one within the last two years.
For example, if you purchased a home 10 years ago, sold it five years ago, and have been renting ever since, you would still be eligible to take advantage of this allowance. Furthermore, if your spouse also falls under the same circumstances, they, too, are considered a first-time homebuyer and would be able to take a penalty free distribution on their IRA as well.
How much you’re able to take to purchase a home depends on the type of IRA you own so be certain to consult a tax professional to see what you would be allowed as a penalty free distribution.
Jeremy Wallace is founder and chief investment officer at Wallace Hart Capital Management, an independent financial services firm committed to offering comprehensive advice and customized services. Jeremy has 20 years of experience in the financial industry and is passionate about helping clients preserve and enhance their wealth so they can pursue their passions. Jeremy graduated from Emory University with a degree in international economics and a certificate in financial planning. Outside of the office, Jeremy spends most of his free time with his wife, Julie, and their three children, Isabel, Lincoln, and Reid. He is an avid Chicago Cubs baseball fan, and he enjoys golfing with his wife and traveling with his family. Learn more about Jeremy by connecting with him on LinkedIn.