The Do’s and Don’ts of IRA Investing

An Individual Retirement Account, more commonly known as an IRA, is a standard savings account approved by the IRS that grants significant tax advantages for users. While retirement is the most common way people use IRAs, it’s not the only way IRAs can be used. In fact, a common misconception around IRAs is that the account itself is an investment. In reality an IRA serves as the holding place for investments like stocks, bonds, mutual funds, and other assets. In today’s post, we explore the other ways IRAs can be used like for the down payment of a house, to cover college education costs, for medical expenses, as a tax-free gift to beneficiaries, as disability income, or even to purchase investment properties.

Traditional IRA vs Roth IRA

To begin our discussion on IRAs, it’s first important to distinguish the differences between a traditional IRA and a Roth IRA. Both are used as a way to grow retirement savings. Where they differ is in terms of taxation; specifically in whether taxation is done prior to adding funds to the account or if it’s done upon withdrawing funds.

  • Traditional IRA: A traditional IRA allows you to make contributions before taxes. This does two things: 1. It allows your earnings to grow tax-deferred and 2. It lowers your taxable income at the end of the year. Money withdrawn from the fund is taxed upon withdrawal. The idea is that many retirees  will likely be in lower tax brackets during retirement and thus will pay a lower tax rate on withdrawals.

  • Roth IRA: Alternatively, a Roth IRA taxes contributions before they’re added to the IRA. This allows the fund to grow tax-free and allows tax-free withdrawals upon retirement.

  • Additional Considerations: Both types of IRAs have set yearly contribution limits, currently $5500 per year for people under 50 and $6500 per year for those 50 and older. Each account type also has set income thresholds (click here for more info). Also important to consider is the flexibility difference between accounts, Roth IRAs offer more flexibility in terms of withdrawal than traditional IRAs. With Roth accounts, you can pull out contribution amounts, but not earnings, without penalties. We advise clients to diversify as much as possible. If your workplace offers a tax-deferred 401(k), similar to a traditional IRA, then consider adding a Roth IRA to your portfolio to allow for increased withdrawal options during retirement.

How can IRA’s be Used Besides for Retirement Savings?

Now let’s move on to lesser known areas of IRA investing. What other ways can IRAs be used besides for retirement saving? IRAs can be used for the down payment of a house, to cover college education costs, for medical expenses, as a tax-free gift to beneficiaries, as disability income, or even to purchase investment properties.

These uses are all sanctioned withdrawal exceptions by the IRS and allow account owners to pull contributions (not earnings) from their account without penalties or taxes. Typically, if you were to withdraw earnings from your account for any other reason than specifically sanctioned exceptions, you would face a 10% early withdrawal fee and subsequent taxation.

  • To buy a house for first-time home buyers: First-time home buyers can withdraw up to $10,000 tax-free to be used towards the down payment of a home purchase. Conditions, like the 5-year rule that states funds must be in the account for at least five years before being withdrawn tax free, must be met.

  • To cover college education costs: You can withdraw funds tax-free to cover college education costs for yourself, your spouse, children, or grandchildren. However, this should really be done as a last resort and not as a college savings strategy. Instead, you should contribute to a 529 college savings plan.

  • To cover medical expenses: IRAs can be used to cover relevant medical expenses that exceed 7.5% of your annual income. Remember you will still owe ordinary tax on all withdrawals from traditional IRAs.

  • As a tax-free gift to beneficiaries: By signing a beneficiary form with your IRA you can transfer ownership to your children, grandchildren, or whomever you decide upon your death. Roth IRA beneficiaries will receive the fund with tax-free withdrawals while traditional IRA beneficiaries will be required to pay tax upon withdrawal of funds.

  • As disability income: If you become disabled and are unable to work, you may be able to tap into your IRA fund to use the resources without paying the 10% penalty fee. To qualify for this, you must provide proof of disability from your physician.

  • To purchase investment properties: IRAs can be used to purchase investment properties. Doing so requires a few steps, you must first open an IRA custodial account and transfer money from an existing IRA into it. Eligible properties must be business properties and cannot be a personal residence, second home, or rental property.

For more information on how to utilize IRA investments and to create a personal financial strategy for your situation, contact TrueNorth Wealth to schedule a free consultation today: 801-274-1820 or email info@truenorthwealth.com.

TrueNorth Wealth is a financial and wealth management firm specializing in personalized financial guidance to individuals and businesses. For a free financial consultation, please call TrueNorth Wealth: 801-274-1820 or email info@truenorthwealth.com.