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What is IRA Basis?
With so many options available these days for retirement investing opportunities, it is hard to know where to start or which investments are right for you. To further complicate things, retirement investing is regulated by the government and as such there are tax laws that all investors must follow. These tax laws range from yearly contribution maximums to required minimum distributions. All of the laws and government regulation can seem a bit gratuitous, but this is a bit of a double-edged sword because the government regulation is what allows all retirement savings to be tax-advantaged which is to everyone’s benefit.
Types of IRAs:
The first decision that investors must make when deciding on individual retirement savings is figuring out which type of individual retirement account or IRA is best for them. IRAs are considered Traditional or Roth. Both are tax-advantaged accounts but how they are tax-advantaged varies and there is something called an IRA basis that determines your tax liability.
Traditional IRAs are tax-advantaged on the front end. Money invested into a Traditional IRA reduces taxable income which makes the funds technically “not taxed.” Uncle Sam wants his cut sometime though, so money invested in a Traditional IRA is taxed on the back end when the money is taken out of the account.
Roth IRAs are the opposite of Traditional IRAs as the money invested in the Roth is after-tax dollars. Money invested in a Traditional IRA reduces your taxable income and money invested in a Roth IRA does not. However, because the money invested in a Roth has already been taxed, Roth IRA participants can pull money out of their IRA without tax consequences in retirement.
Traditional IRAs are best for people who need to reduce their taxable income now and anticipate that they will be in a lower-earning tax bracket later. Roth IRAs are best for people who want a more see what you get approach in their retirement dollars and don’t want to have to worry about tax implications later on.
Both Traditional IRAs and Roth IRAs have an IRA basis that must be tracked on IRS Form 8606. IRS basis is the money in an IRA (whether Traditional or Roth) that has already been taxed or was non-deductible. Knowing what you know about Roth IRAs, you know that all Roth contributions are IRS basis. Some traditional IRAs have a basis as well if there is a rollover from another qualified account involved like a SIMPLE or SEP.
IRS basis must be kept track of or tax-free withdrawals can quickly become a taxable event if there is no proof that the money invested was taxed already. Thankfully the IRA basis only matters for withdrawals made “early” or before the age of 59 ½. Withdrawals made from IRAs are subject to a 10% early distribution penalty if they are made before 59 ½ and they may be subject to taxation on the outgoing side too if there is not an accurate Form 8606 keeping track of the after-tax money invested.
Form 8606 is also used when converting a traditional IRA to a Roth IRA. Taxes must be paid when the conversion happens and, thus, all the money in the new Roth IRA is considered an IRA basis for taxation purposes later on.
Investors and/or their tax professionals are responsible for keeping track of the IRA basis.
Now that we know a little more about Roth and Traditional IRAs, how do we pick which IRAs are best to help us meet our goals? The Roth or Traditional IRA question can be answered by whether or not an investor needs a reduced tax liability today (use a Traditional IRA) or would prefer no taxes on retirement dollars (use Roth IRA). Once that is decided, investors, can make decisions about what assets to choose inside their IRA.
There are some universal principles of investing that every investor should take into consideration when making decisions about their future. Investors first want to identify their risk tolerance and what goals they have for their investing. Once those two things are decided and investors are ready to proceed, they need to make sure that their accounts are properly diversified. No investor should have all of their money in one asset or eggs in one basket.
There are lots of ways to diversify a portfolio, but generally speaking, investors want to have several different assets in their portfolio that are all going to react in different ways to the same market event. It is a way of grounding your portfolio while also taking advantage of any potential growth.
A great grounding asset for portfolios is investing in precious metals- more specifically, gold and silver. Gold and silver are considered hedges to inflation because despite what paper currency is doing, gold and silver will always be a store of value and are impervious to political and economic uncertainty. Precious metals are highly liquid but also scarce enough to ensure that the supply and demand scales are generally in the investor’s favor. Unlike dollars, governments can’t print more gold bars.
Gold and Silver IRAs:
Investors looking to add gold and/or silver into their retirement investment portfolio will need to find a self-directed IRA. Self-directed IRAs are available in both Traditional or Roth – the same rules for which one is best still apply- and they simply allow investors to hold a variety of investments that cannot be held in standard Traditional or Roth IRAs.
Self-directed IRAs allow investors to participate in gold and silver through the use of a custodian who will physically hold the gold and silver for the investor, so they don’t have to try and figure out how to store physical metals. The responsibility for finding a reliable custodian falls on the investor, but there are plenty of custodians out there who have a preferred relationship with hundreds of brokers and are a great place to start looking.
Once investors have settled on which custodian to use and which metals, they can fund their IRA and purchase gold and silver inside of it, thereby ensuring that at least a portion of their retirement investment is in an asset that will protect them from inflation. Gold and silver IRAs do typically have slightly higher fees but that is because storing and protecting actual metals is an expensive endeavor.
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Despite which type of individual retirement account is best for you- Traditional or Roth, there are some important things to consider like ensuring that your IRS basis is accurately tracked and that the investment assets you choose are moving you closer to your goals while protecting your portfolio at the same time.
Remember that you are responsible for keeping track of IRA basis or your after-tax/non-tax-deductible IRA Contributions year after year. Saving this information will keep you from being double-tapped by Uncle Sam in the event of an early distribution situation.
As for ensuring that your IRA assets are helping you meet your goals, try to strike a balance between growing and protecting. The balance between the two can seem tedious, but adding gold and/or silver to your portfolio can certainly offer a solid foundation of protection.
I hope you found this short post about IRA basis to be helpful and that you now have a better understanding on what it is and if it is something for you or not. Please share your own experience on this subject in the comment section below as it can help others make better decisions! Also, if you got any questions about this I would be more than happy to answer them below!
I wish you success!
Meagan,, financial advisor and a team member of Gold Retired