Whether it's Roth or traditional, an individual retirement account (IRA) could end up being one of the most important parts of your investment portfolio. But the government isn't making things easy for you, and the IRA tax environment is constantly shifting and evolving.
The year 2015 brought about relatively few major events to the IRA world, but some minor changes could still influence your IRA investments. Here are the three biggest IRA headlines in 2015.
A limit on limits
For 401(k) contributors, 2015 was a year to celebrate -- a $500 increase in contribution limits equated to a 2.9% bump for all users, and a similar $500 boost to catch-up contributions amounted to a sizable 4.3% total increase for those aged 50 and over. Sadly, the same news doesn't rank among the biggest IRA headlines in 2015, because there was no such increase.
In 2015 (as was the case in 2013 and 2014), contributions for all your traditional and Roth IRAs max out at $5,500, or $6,500 if you're age 50 or older. And don't hold your breath for 2016, either. The IRS has already announced contribution limits for next year -- and they're the exact same.
While contribution limits aren't going up, there were some minor 2015 changes on income phase-out thresholds. For contributing to Roth IRAs, the maximum income threshold rose by $2,000, to $183,000 for joint filers and to $131,000 for single filers. Phase-outs for being able to deduct traditional IRA contributions for those covered by an employer retirement plan also climbed $1,000 to $2,000 from 2014 levels, with singles having their deductions phased out between $61,000 and $71,000 and joint filers seeing phase-outs between $98,000 and $118,000. For those whose spouses are covered by a plan, phase-outs now go from $183,000 to $193,000 for 2015.
This season, give the gift of IRA distributions
For generous and wealthy IRA holders, charitable giving just got a whole lot more predictable. Congress came through in 2015, passing a law that permanently excludes charitable donations from IRA distributions from being classified as income.
That means that, as you begin to draw down your traditional IRA in your later years, your supposedly taxable income goes directly to donations, and keeps your taxable income lower than it would otherwise have been. The exclusion is good for up to $100,000 per year and may be especially useful for those aged 70-1/2 and older, who are required to make minimum annual withdrawals from IRAs. So pick your preferred charity -- GiveWell.org is an excellent place to start -- put a bow on your IRA distribution, and get ready to wave that taxable income goodbye.
The state of things
Americans are more mobile than ever. The year 2015 marks the 70th birthday of the first baby boomers, and where those boomers choose to retire could have major repercussions on their tax status. While some states have sales tax, income tax, and even Social Security tax, others don't.
According to Kiplinger's 2015 ranking, Alaska actually ranks as the most tax-friendly state, while Vermont ranks as the worst. Obviously, there are other considerations than taxes for where one will retire -- heat and sunlight are priceless to some -- but knowing the tax status of where you are now compared to where you might retire will also help you decide between a Roth IRA and a traditional IRA.
If you currently live in a tax-friendly state but plan to spend your golden years in a tax-heavy state, then you may want to invest using a Roth IRA. You'll pay tax today, but it will be at a lower rate than you'll pay in a higher-tax state in retirement. On the other hand, if you live in a tax-heavy state now but are headed to tax havens like Alaska, Nevada, or Florida in retirement, using a traditional IRA lets you deduct money now and save more on your taxes, you'll pay little or no state income tax on retirement distributions later.
2016 and beyond
Deciding between a traditional IRA and a Roth IRA often boils down to a single question: Is your current tax bracket lower than what you expect it to be at 59-1/2 when you're able to start taking withdrawals? If so, go with a Roth. If not, stick with traditional.
But this question overlooks one important possibility: The tax structure 10, 20, or 30 years from now could look very different from the one today. With our government's political and financial positions reshaping themselves every year, your 2015 takeaway may be to simply hedge your investment tax structures -- a little Roth and a little traditional to diversify future tax risk.
The year 2016 will undoubtedly bring about more change, but living by the rule to save early and often will ensure that your retirement -- whether packed in an IRA, 401(k), or an envelope stuffed under your mattress -- will be as smooth as it can be.
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