Ask an Expert: A Primer on IRAs

In this primer, we explore the traditional IRA and the Roth IRA in depth, including the benefits and limitations of each, along with a discussion about the possible utility of converting a traditional IRA to a Roth IRA. Additionally, this primer discusses the possible selection criteria of advisers for retirement plans. Lastly, this primer issues a caveat to the reader and investor about IRA beneficiary designations and the possible tax consequences of same.

What is a traditional IRA?

A traditional IRA permits investors to make annual contributions of $4,000 in 2007 ($5,000 in 2008) that are tax deductible from ordinary income with some limitations, such as individuals covered by an employer plan. For those individuals age 50 and older an additional catch-up contribution of $1,000 is permitted.

All contributions to a traditional IRA must be made by the tax filing deadline of April 15 (or other date set by the IRS) of the following year.  As with any investment, it is better to make the contributions early to enjoy the compounding of the investment.  For further exploration of investment basics, see our article titled “The Five Rules of Investing Success” published July, 2006 in The Greater Lansing Business Monthly and available at under the investment link.

Can I roll over my 401(k) or other employer-sponsored plan to a traditional IRA?

Generally, yes.  It is usually preferable to roll over these retirement plans due to greater flexibility and control, especially if the funds are to be managed by professional, fee-only fiduciary investment advisers.   For further exploration of retirement roll overs see our article titled “Ask an Expert: Retirement Rollovers” published September, 2006 in The Greater Lansing Business Monthly and available at under the investment link.

At what age may I begin withdrawing money from my IRA without penalty?

Within qualified exceptions to be explored with one’s adviser, an individual may begin distributions from a traditional IRA without penalty upon obtaining the age of 59 ½.  Any distribution made prior to age 59 ½ that is not covered by an exception is subject to a 10 percent penalty, in addition to ordinary income taxes.

What is a required minimum distribution at age 70 ½?

Upon obtaining the age of 70 ½, an individual must begin taking annual distributions from a traditional IRA.  The Internal Revenue Service publishes a standard life expectancy table that is used in determining your required minimum distributions.  Failure to take a distribution will result in a 50 percent penalty of the difference between the required minimum distribution and the amount you actually withdrew.   Many investors seek to convert their traditional IRAs to Roth IRAs to avoid or limit their required minimum distributions.

What is a Roth IRA?

An individual with earned income may contribute up to $4,000 (for 2007) into a Roth IRA.  This contribution is not currently deductible against ordinary income; however, all contributions and investment earnings are completely sheltered from taxation.  Similar to a traditional IRA, an individual may begin receiving qualified distributions (i.e., without penalty) upon obtaining the age of 59 ½ or within qualified exceptions to be discussed with your adviser.

Should I convert a traditional IRA to a Roth IRA?

The classic law school refrain applies to this question: “it depends.” Depending upon your current income and your corresponding tax bracket, along with your income need, if any, for distributions from your IRA upon obtaining the age 70 ½, your adviser will construct a decision tree for analysis.  If it is determined, upon consultation and review with your adviser, that it is beneficial to convert (or partially convert) a traditional IRA to a Roth IRA, your adviser should strategically plan for distributions based upon tax modeling.  If it is determined that a conversion is appropriate, then the conversion must be completed by December 31 of the calendar year.

A word of caution: Your adviser should be very well versed in accounting and taxation, and preferably an accountant and/or lawyer. If converted correctly, an investor could greatly benefit from the advice; if converted incorrectly, an investor could face substantial avoidable tax.  It is highly recommended that you consult your adviser upon pending retirement, or years before obtaining the age of 70 ½.

There are many types of advisory firms; what in your opinion is the most ideal from an investor’s perspective?

Cleary, a fee-only fiduciary advisory firm is the most ideal for an investor (not merely fee-based, which is part fee and part broker commission, or fee offset).  Unlike a brokerage firm or fee-based broker, which often only has a fiduciary duty when imposed by federal pension law, a fee-only fiduciary advisory firm always has a fiduciary duty, always is fee-only, always is independent and objective, and never has a conflict of interest.  Additionally, many fee-only firms utilize institutional (low cost) as opposed to brokerage retail funds (high costs and commissions and possibly surrender fees to cover commissions).

Perhaps most important to investors who trust all or part of their retirement savings with their adviser, it is best to look to firms with advisers that hold advanced degrees such as doctoral or master’s degrees, in addition to their experience and industry designations.  Unfortunately, while there are some exceptions, most industry designations are not academically based programs; instead, they are as much about marketing and sales training as they are the very basics of investments.

For further exploration of the various investment advisers and brokers see our article titled “Ask an Expert: Stockbrokers, Fee-Only Fiduciary Advisers, and Hedge Funds” published July, 2007 in The Greater Lansing Business Monthly and available at under the investment link.

Caveat concerning beneficiary designations

An issue not covered in this article due to the nature of it as a primer is the beneficiary designation for individual retirement accounts and the potential tax consequences of said designation.  We highly recommend that you speak with an adviser very well versed in accounting and taxation, preferably an accountant and/or lawyer, regarding the correct IRA beneficiary designations for tax purposes.   An incorrect beneficiary designation could result in substantial avoidable taxes.

Stephen L. Hicks, JD, MS and Roger L. Millbrook, JD, CPA/PFS, both hold doctoral degrees, and other graduate degrees or designations in the area of financial services and are principals of Siena Capital Management, LLC, a fee-only fiduciary investment advisory firm, and principals of Siena Accounting Services, Inc. 








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