Investment Commentary


Your IRA Reset: How to Assess Your IRA Planning in 2021 and Beyond

By Mark T. Robinson, CFP®, CTFA - Managing Director


August 9, 2021 - 
A once-in-a-century global pandemic has taken a profound personal and professional toll on families of wealth. Family enterprises have been strained by stagnated revenues, shuttered store fronts, or supply chain challenges. Family harmony has been tested by lockdowns and significant lifestyle modifications. Financial decisions have been under constant evaluation, at the mercy in many ways of legislative action.

Individual retirement accounts, or IRAs, were one area of evolution in the last 18 months. Emergency legislation altered longstanding tax laws, while economic dislocation modified many people's current thinking regarding retirement and estate planning. Now, as the pandemic evolves and the economy re-opens, re-evaluating your IRA planning is an essential step in a broad review of your accounts, strategies, and multi-generational goals.

IRAs are powerful retirement planning vehicles, and with that power has come significant adoption. Roughly 42 million American households own an IRA, accounting for over 10% of all household financial assets. IRAs offer tax flexibility—tax deductibility or tax-free compounding depending on the type—but also inflexibility in fixing many serious errors. IRA rules are complicated and simple mistakes can trigger substantial taxes and penalties.

Trusted advisors must be able to navigate the complexities involved with different IRAs. As a family of wealth, understanding the basics and knowing the latest changes can make a big difference in your family's multi-generational wealth.


The Foundation of Your IRA Planning

An IRA allows you and your loved ones to save for retirement, and potentially save on taxes. There are various types of IRAs with different rules and structural advantages. The two most common are Traditional IRAs and Roth IRAs.

You can contribute pre- or after-tax dollars to a Traditional IRA, the money grows tax-deferred, and withdrawals, not including after-tax contributions, are taxed at your current income tax rate at the time of withdrawal. Contributions to a Roth IRA are always with after-tax dollars, the funds compound free of tax, and you can generally take tax- and penalty-free distributions after you reach age 59 ½ (more on that in a bit).

With that brief comparison, the obvious question is, "which is right for me?" Simply put, a Traditional IRA works well if you surmise you will be in the same or a lower tax bracket when starting withdrawals. Conversely, a Roth IRA may be best if you expect to be in a higher tax bracket when taking withdrawals, allowing you to pay tax now at a lower rate. In most situations, Roth IRAs are the obvious choice if you are just starting a career. It is likely you are beginning to  save in the lowest marginal tax bracket for your lifetime, and today's tax rates are already hovering at or near historic lows.

One potential advantage to the Traditional IRA is the current-year tax benefit. The following table reflects the rules for Traditional IRA deductible contributions if you are covered by a retirement plan at work—there are no such thresholds for non-deductible contributions. If you are not covered by a retirement plan, the contribution is fully deductible. The table outlines the modified adjusted gross income (MAGI) parameters and the deduction limit for single tax filers and those married couples who file jointly (Table 1). As you can see, families of significant wealth, especially those leading family enterprises, often have MAGI above the deduction threshold, but second- or third-generation family members may not.

Table 1 IRA Deductions

No matter which IRA you choose, the maximum contribution for 2021 is $6,000, with an additional $1,000 allowance if you are age 50 or older. You must have earned or alimony income equaling the amount of your contribution. If your spouse does not work, you can make an IRA contribution for them as long as you file a joint tax return and meet the income limits.

Remember, contributions to a Traditional IRA can come from pre- or after-tax dollars, while all Roth IRA contributions are after-tax. There is no age restriction on contributions, but there is an earned income eligibility threshold for contributions to a Roth IRA (Table 2).

Table 2 Roth IRA Eligibility

Beyond contribution rules and limits, you should understand the basics governing withdrawals. As a traditional IRA owner, you can withdraw funds at your current income tax rate without penalty starting at age 59 ½. If you withdraw funds before that age, you must meet one of the designated exceptions or face a 10% early distribution penalty plus applicable ordinary income tax. Traditional IRAs have a Required Minimum Distribution (RMD) starting at age 72. If you own a Roth IRA, withdrawals are penalty- and tax-free after five years and age 59 ½. Most importantly, a Roth IRA currently does not have an RMD, so the account grows tax-free until the account owner dies. In addition, you are allowed to withdraw Roth IRA contributions (before investment gains) at any time free of tax and penalty. Yes, you read that correctly! Contributions are assumed to be withdrawn first in any Roth IRA distribution. Each year you file your tax return, IRS Form 5498 keeps track of your Roth IRA contributions. Beneficiaries of your Roth IRA will be required to take distributions, but those distributions will be tax-free.

Roth IRAs are really the only investment vehicle in which you can look at the entire account value as yours. Most investment accounts have some inherent tax liability from unrealized gains or requirements to make distributions taxed as income.

If you like the sound of a Roth IRA, but you exceed the income limits for eligibility to make a contribution, there are several possible workarounds.

  • You can make a non-deductible contribution to a Traditional IRA and roll over the funds into a Roth IRA. This is called a "backdoor Roth conversion."
  • You can convert the entire or a portion of a Traditional IRA to a Roth IRA.
  • If you are employed, and your empower offers a Roth 401(k), you can contribute and then eventually roll the funds over to a Roth IRA after separation from service.

A word of caution—reach out to your advisor to understand the tax consequences of any rollover or backdoor Roth conversion from a Traditional IRA to a Roth IRA.

With the expectation of higher taxes in the not-so-distant future, funding a Roth IRA now could be advantageous. If you are thinking about a rollover or backdoor Roth conversion, you must understand the tax consequences. Make sure to consult your Relationship Manager, advisor, or CPA to discuss these options in greater detail.


SEP IRA

Beyond Traditional and Roth IRAs, SEP (Simplified Employee Pension) IRAs are an advantageous option for business owners. If you are running a business, you can contribute to IRAs set up for your employees. All contributions are tax-deductible, the funds grow tax-deferred, and withdrawals are then taxed as current income. You can contribute the lesser of 25% of compensation or $58,000 in 2021, significantly more than the contribution limits for a Traditional or Roth IRA.

SEP IRAs are ideal for business owners with a few or no employees. If you have employees whom IRS deems eligible plan participants, you must contribute on their behalf, and those contributions must be the same percentage for all employees (including yourself!). Eligible participants include employees ages 21 or older, who have worked for your company for three of the past five years and have earned income equal to or above $600 from you in the past year.

If you are self-employed, however, SEP IRAs do not require yearly contributions. You can even wait and decide to contribute up to and including the tax filing extension period of October 15 of the following year.

Below, you can weigh the pros and cons before setting up a SEP IRA for yourself or your small business (Table 3).

Table 3 SEP IRA


IRA Planning Changes in 2020 and 2021

As America ages and the massive generational wealth transfer continues, Washington, D.C. is paying greater attention to retirement accounts. The 2019 Setting Every Community Up for Retirement Enhancement Act (SECURE Act) was a consequential law that emerged from this renewed focus, triggering sweeping changes to IRAs.

These changes included:

  • The elimination of the age 70 ½ limit for making Traditional IRA contributions. Under previous rules, you could not make any contributions to Traditional IRAs after age 70 ½. Effective from January 1, 2020, you can make contributions to a Traditional IRA at any age if you have earned or alimony income.
  • The raising of the RMD age to 72. Previously, you had to begin taking required minimum distributions from Traditional IRAs at age 70 ½.

Then, in the fog of the COVID-19 pandemic, Congress passed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which waived RMDs for 2020 and allowed tax-advantaged coronavirus-related distributions (CRDs) of up to $100,000 within the 2020 tax year.

RMDs are now required for the 2021 and all future tax years. You may experience a higher tax liability in 2021 compared to 2020 because of the resumption of the RMD.

For taxpayers who were not previously subject to RMDs, the new required beginning date is April 1 of the year after you reach age 72. And starting in 2022, the RMD tables will be updated to reflect longer life expectancies, in turn lowering your annual RMD.

You also have several ways to delay or avoid tax on an RMD. Qualified charitable distributions (QCDs) allow you to make charitable contributions directly from your IRA to one or more charities up to $100,000 per year. If you file taxes jointly, your spouse can also make a QCD from his or her own IRA within the same tax year up to the limit. QCDs are not taxed and count toward satisfying your yearly RMD. And remember, QCDs can still be made starting at age 70 ½, which would lower the balance in your IRA and result in lower RMDs by the time you reach your new required beginning date.

You can also convert a Traditional IRA to a Roth IRA, as Roth IRA owners do not have RMDs. This is a great strategy during a tax year in which your income is down (pushing you into a lower tax bracket) or if you want to reduce your taxable estate. By paying the upfront tax bill, you effectively make a tax-free gift to your beneficiary. If the lifetime gift tax exemption is reduced and/or the estate tax rate is higher than the highest marginal tax rate in the future, a Roth conversion could be even more appealing. If you will have a taxable estate and your marginal tax rate is less than the estate tax, you may want to consider converting to a Roth IRA now at lower income tax rates.

You should also assess Roth conversions as a potential estate planning tool, especially as an alternative to the now-limited stretch IRA. The stretch IRA was a popular estate planning strategy used for non-spouse beneficiaries—often a child or grandchild—to extend the tax-deferred benefits of an inherited IRA by taking distributions over the lifetime of the younger beneficiary. However, The SECURE Act effectively eliminated this strategy for most deaths that occur after December 31, 2019.

Under the new rules, IRAs inherited by non-eligible designated beneficiaries (NEDBs)—like grandchildren or older children who have attained their majority (or age 26 in the case of students)—must be depleted within 10 years of the death of the original IRA owner.

This change has major implications for young beneficiary inheritors who had minimized distributions and annual taxes and had capitalized on long-term, tax-advantaged growth within the IRA. Now, Roth IRA conversions could serve as a work-around. A conversion would entail a substantial tax hit upfront, but once converted, the funds in the Roth IRA would grow tax-free with no RMDs during the owner's lifetime.

Upon his or her death, the Roth IRA could be left to a NEDB, who could allow the funds to accumulate tax-free for 10 years without an RMD then withdraw the total assets tax-free.

It is important to note that eligible designated beneficiaries—such as surviving spouses, minor children, disabled individuals under the strict IRA rules, chronically ill individuals, or individuals not more than 10 years younger than the IRA owner—can still employ the stretch strategy.


Your Next Steps

The IRA tax rules are complex and unforgiving, which requires coordination among your investments, tax, and estate planning professionals. At Pitcairn, those professionals reside in one family office, partnering to establish a holistic view of your accounts, tax situation, and future goals. Whether you want to use your IRA for charitable giving, retirement savings, and/or estate planning, our team leverages the resources of Wealth Momentum®, Pitcairn's experience-based service model to drive synergy among these financial dynamics—building a plan sensitive to taxes, keen to market dynamics, in-line with legislative changes, and tied to your family and financial goals.



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About Pitcairn

Pitcairn is a true family office and leader in helping families navigate the challenges and opportunities created by the interplay of family and financial dynamics. Through Wealth Momentum®, an experience-based family office model, Pitcairn helps families achieve a more effective and complete experience. Since its inception, Pitcairn has partnered with some of the world’s wealthiest families to meet their needs and drive better outcomes – year to year, decade to decade, generation to generation. Today, Pitcairn is recognized as an innovator, guiding families through generational transitions and redefining the industry standard for family offices. The firm is located in Philadelphia, with offices in New York and Washington, DC and a network of resources around the world.