Video transcript below (auto-transcription may cause some errors) –
Hi. This is Abhinav, and I welcome you. In the previous video, I had covered about, understanding 401 k plans, and it’s the taxation aspects. In this video, I’m taking up individual retirement plans and the taxation aspects in US. The taxation of, IRA plans, in India, I will take up in a separate video, so stay tuned.
Okay. So let us start. I’ve made few pointers. So basically, what are IRAs? IRAs are similar to 401ks only.
Now 401ks are basically employer employee plans. Right? Like, if you if you are an Indian, you will understand it this way that, 401k is like employer provident fund, and IRA is like public provident fund Right? So IRA is like a tax deferred investment account in US that helps you save for your retirement, and it’s basically of mostly, it’s 2 types. 1 is traditional IRA and Roth IRA.
They have some differences, which I will take up. Who can contribute? Now anyone can contribute. Right? So even a self employed person can contribute.
Anyone who has earned income from wages or self employment. Right? So 401k, only that person can contribute who is in a job with a particular employer. But, IRA, anyone can contribute irrespective of age. There is no age limit also for contribution.
The only requirement is that you must have had earned income from the wages. If you don’t have earned income, for example, if you have income only from for, dividend, interest, right, then you cannot contribute. Right? And you can only contribute up to the earned income. Right?
Okay. So what is the maximum contribution that you can do, which is which can be deducted? Right? See, you can contribute any amount, but only a certain till a certain amount can be deducted. And that is where there is a, you know, the magic of the IRA comes in.
Right? That you can it’s a basically pretax contribution. That means you contribute, it gets deducted from your income. So whatever the amount that gets deducted is basically you allow it to grow in a tax deferred that tax deferred way, right, till you take the withdrawal. Right?
So that’s the big significant benefit. So, basically, IRS has restricted the maximum contribution that a person can make, which can be deductible. You can make a nondeductible contribution over and above this deductible contribution. For this, you have to file a certain form will which will come to. But, otherwise, this is the basic limit where you get this benefit of a deduction.
What is the limit? It is $7,000 per year. Now this is 2024 limit. This limit will adjust every year. It will increase every year.
It’s inflation adjustable. Right? It is $7,000 per year, not $8,000 if you are 50 years or older. So for, less than 50 years age, it is $7,000, $8,000 to 50 years or older. This is the maximum contribution.
Now this is the con combined contribution limit for Roth or traditional. Whatever you want to invest the deductible portion, this is the limit. Now contribution limits per spouse and can be claimed jointly on tax return, excess contribution penalty of 6%. So, basically, for 2 spouses who are filing a joint return, this particular limit applied to individual person. Right?
So 7,000, 7,000. Both husband and wife can take 7,000, 7,000. Right? Both spouses can take and claim on the joint return. If you make excess contribution, then there is a penalty of 6%.
Right? Now, for IRA, there are phase out rules based on modified adjusted gross income. If any of the spouse is eligible to contribute to an employer plan, for example, a four zero one three plan. Right? So now for IRA, traditional IRA, so I meant here traditional IRA.
Traditional IRA, there is a phase out route that, yes, you can contribute up to $7,000 and, you know, or $8,000. But if your if any of them any of them spouses is eligible to contribute for an employer plan like 401 k. Right? For example, husband in a is in a job where there’s no 401k. Wife is in a job where she can opt for a 401k, but she doesn’t opt for.
Even then, there are phase phase out rules. Like, I think somewhere around 70, $80,000, there’s a phase out. That means beyond that, if the income is there, modified adjusted Maggie beyond that, if that income is there, then you cannot contribute, right, to a traditional IRA. So that is a very important tool that needs to be kept in mind. It need not be that the person contributes to a 401 k, but even if one of the spouses is eligible also, then it gets restricted.
So that those limits need to be kept in mind. Right? Now for Roth, there are separate income based phase out rules. Be beyond a certain income, you cannot contribute to a Roth IRA. Right?
Okay. Now then there are certain provisions for spousal contribution. Now one spouse has earned income, right, which qualifies for investment. So as we discussed earlier, you can only contribute if you have an earned income from wages or self employment. So take a case of a husband and wife.
Husband is into a job, and he’s earning, like, 10,000, yeah, $10,000. Right? In so he’s having that own income from wages, and he can contribute up to $7,000. But wife doesn’t have any particular income. Right?
Wife doesn’t have any income. In that case, what the husband is doing is that it is called spousal contribution rule. That means out of $10,000, 7,000 is in his name, and $3,000 can go in wife’s name. So wife can also apply. Right?
For that, I think there is a requirement of filing a joint return. Right? And that $3,000 can be invested in the wise name. Right? So that beneficial rule is available.
Okay. Now contribution is deducted from income. It’s a pretax contribution. Roth contributions are not deductible. Right?
Roth are basically post tax. You contribute from post form post tax money. So basically, they are not deductible. Right? But the withdrawal is tax free for Roth.
Now non deductible contributions can also be made, as I discussed earlier, if you want to contribute anything over $7,000, right, you can contribute. No problem. But you need to file form 8606. Right? And it says advisable if you want to contribute, you should contribute in Roth because when you contribute in Roth, then what happens is the withdrawal is tax free.
Right? However, if those who are planning to return back to India, then Roth is not advisable because of the complicated taxation of Roth in India. Right? You may explore other options. But if you want to contribute above over and above, 7,000 as a non-repatriable contribution, you must file form 8606.
Otherwise, what happens is at the time of withdrawal, everything gets taxable. If you file 8606, then to the extent that you file for 8606, the contribution at the time of withdrawal will not be taxable because it’s a nondeductible contribution at the time of making the payment. So that needs to be kept in mind, and this form 8606, all these forms need to be carefully preserved till the time of withdrawal because withdrawal can be, like, 20, 30 years down the line. So you need to, you know, preserve the filings if you are making non deductible contributions. Okay.
You can contribute to multiple IRAs subject to the oral contribution. So if you can have multiple accounts. So right? It’s not like in India, you have the accounts. 1 person can only have 1 account.
Here, you can have multiple IRAs with, like, different brokerages, and you can all the contribution to the IRAs together in aggregate should not cross the maximum deductible contribution per year. Otherwise, there is an excess contribution penalty that applies. You can contribute to Roth over and above the IRA. Over and above the IRA, you can contribute to Roth. If the income based phase out rules do not apply to you, if your income is below the phase out rule for Roth, then you can consider anything above the deductible, limit for 401 k, you can you can explore Roth IRA.
Right? It’s good from an overall estate planning perspective also because the withdrawal will be tax free to the beneficiaries. Now last date for making the contribution, like in the previous video we discussed about 401 k, it’s December 15th. However, in IRA, it is April 15th of the year following the calendar year. So you get, like, three and a half months of post year tax planning window you get that you can still after the tax year is closed, you can decide that I want to contribute more, into the into the IRA and save more tax, but there is no extension.
So if you if you opt for a extension to your tax return, you cannot extend the contribution. The timeline for making the contribution, is April 15th only. Right? So you need to keep in mind. Now coming to taxation aspects, now traditional IRA in Roth IRA, the taxation aspect is different.
Right? Now traditional IRA, the withdrawals are fully taxable, right, in US at graduated rates. Now at graduated rate is the slab rates. Right? It’s fully taxable.
Whatever withdrawal you are making, it is fully taxable. Now there are separate tax rules for non resident aliens. So for example, you have returned back to India, right, And at the time of you are in India, you qualify as a you are not a US citizen or a green card holder. You qualify as a nonresidential for US tax law. Then the withdrawal will be taxable to you, but there’s a separate tax rule.
What the tax rule is? In case of non resident I’ll make a separate video on taxation on non resident aliens detailed video, but basically what the rule is that the contributions there are 2 components of the withdrawal. 1 is the contribution that you had made. 2nd is the income on the contributions. So the contributions will be treated as effectively connected income, ECI, and it will be taxable at graduated rates similar to in the US for normal US citizens however the interest income the dividend income that you get from the investment of that money that will be taxable at flat 30%.
Right? So that kind of a calculation that you’ll need you’ll need to do. The broker will always deduct a 30% flat, or if there is a, lower treaty rate that, between the country of your residence and the US, if a lower treaty rate is there, then you can opt for a lower treaty rate. For example, for the within India, you can claim, instead of the 30%, you can claim 25%, withholding, 25% tax. So that you can provide the w eight b and that document you can provide to the, IRA provider, and you can so there are separate tax rules for nonresident aliens.
For US citizens, US residents, withdrawals are fully taxable at graduated rates. If you make early withdrawal early withdrawal is what? Before age 59.5, if you are making the withdrawal, then there is an early withdrawal of penalty of 10%, which is tax only. IRS was an additional tax of 10%. That will be chargeable.
Now for Roth IRA, it is a bit different. In Roth, the withdrawals of the contributions can be done anytime. Right? So you make the contributions and contributions are post tax. Right?
They you they you do not get deduction for Roth IRA contributions. You can do a withdrawal of the Roth IRA contribution anytime, and they are tax free. Right? Totally tax free in US. Withdrawal of earnings also is tax free provided there are two conditions it should be done after 5 year period from your investment after 5 years from your investment and age 59.5.
Right? If any of the two conditions you don’t fulfill, then it will be taxable, and the penalty of 10% will be applicable. Right? So this is basically the taxation of traditional IRA and Roth IRA on withdrawal. Right?
Okay. Rollover to another IRA can be made. So, for example, you hold IRA with the with the brokerage a and you are moving to a brokerage b. You can do it. Do a trustee to trustee rollover, which is basically called a direct rollover and you can do it unlimited such rollovers in any tax year and the totally tax free it’s non taxable event and in case of indirect rollover you are doing for example indirect rollover is that broker a brokerage a issues you a check of the total fund value.
And within 60 days, you have to, give it to the new brokerage new IRA provider. If you do it within 60 days, then it is a nontaxable event, and only one such indirect rollover is allowed. Now rollover to Roth IRA to the extent of deductible contribution, and then and there is a there’s a 20% withholding tax in case of indirect rollovers. Right? So that you need to keep in mind.
Rollover to a Roth IRA to the extent of deductible contributions. Right? So if you have, like, $10,000 in your IRA, 8,000 is basically deductible, which were basically you had deducted the contribution from your tax returns and 2,000 are nondeductible for which you had filed form 8606. So to the extent of deductible contributions that is $8,000, the rollover to the Roth IRA will be taxable in the year in which you are making the rollover so that you need to keep in mind. Then in case of IRA, you need to, take a required minimum distribution from 873.
Right? However, it’s basically only applicable for traditional IRA. For Roth, there is no such requirement of taking a required minimum distribution. Right? So this is it.
This is about some some bit, some pointers on IRA, individual retirement plans. If you’re planning to move to US, then these understanding you need to have, and the taxation aspects. If you have any queries, any thought on this, do share in the comment section, and I’ll help you. Thank you so much for watching this video. Thank you so much.