Ask Carrie by Carrie Schwab-Pomerantz

Dear Carrie: What's the difference between an IRA and a non-IRA account? Can I put money into either account now that I'm not working and retired? — A Reader

Dear Reader: Transitioning from working to retirement presents new challenges that require you to look at your saving and spending decisions in a whole new way. Having the right accounts for your money is an important consideration, so you're wise to be asking this question now.

There are distinct differences between IRAs and regular brokerage accounts. While you can buy and sell securities (stocks, bonds and fixed income investments) and hold cash in either, there are significant differences in how your earnings are taxed. Plus, there are differences regarding who can put money into what account and how much. Understanding how these accounts differ will help you make smarter decisions about saving, investing and spending during your retirement years.

 

THE TAX DIFFERENCE

An IRA is a tax-advantaged account, designed to allow retirement savings to grow tax-deferred. There are two basic types of IRAs — traditional and Roth. While both offer tax-deferred earnings, there are distinctions between the two that also have to do with taxes:

—Contributions to a traditional IRA are tax-deductible depending on your income and whether you participate in an employer-sponsored plan such as a 401(k). Earnings grow tax-free, and you pay ordinary income taxes when you make a withdrawal.

—With a Roth, there's no up-front tax deduction for a contribution, but you can withdraw earnings income tax free at age 59 1/2 if you've held the Roth for five years.

By contrast, with a taxable brokerage account, you get no tax deductions, and you pay capital gains taxes on any gains you realize when you sell a security. These gains are considered either short-term (investments you've held for one year or less) or long-term (investments you've held more than one year).

You pay ordinary income tax on short-term gains, currently up to 35 percent. But on long-term gains, you pay the federal long-term capital gains rate, currently 15 percent. If your tax bracket is 15 percent or lower, the tax rate is 0 percent — at least through 2012.

 

THE CONTRIBUTION DIFFERENCE

To contribute to an IRA — either traditional or Roth —you must have earned income . For instance, if you're no longer working and have only investment income, you can't contribute to an IRA.

(There is an exception for a non-working spouse as long as the working spouse has earned income equal to any contributions for both.) If you do have earned income, the yearly maximum you can contribute to either type of IRA is $5,000 ($6,000 if you're over 50). There are also maximum income qualifications for contributing fully to a Roth that vary from $125,000 for singles to $183,000 if you're married and filing jointly for the 2012 tax year.

While there's no age limit for contributing to a Roth, with a traditional IRA you can't make contributions past age 70 1/2, even if you continue to work. In fact, you're required to take minimum distributions from your traditional IRA beginning the year you turn 70 1/2.

By comparison, a taxable brokerage account has no income or age restrictions. You can put as much money as you want into the account for as long as you want.

 

TYPES OF INVESTMENTS TO HOLD IN EACH ACCOUNT

Just because you may not be able to continue contributing to your IRA, doesn't mean you don't have to wisely manage the IRA assets you already have — along with the assets in your taxable account. To this end, you should consider what types of investments work best in each type of account.

As a rule, investments that tend to lose less of their return to taxes are good choices for taxable accounts. These include individual stocks you plan to hold more than one year, tax-managed funds, index funds, stocks or mutual funds that pay qualified dividends and municipal bonds. In a tax-deferred account like an IRA, it's best to keep tax-inefficient investments such as individual stocks you plan to hold one year or less, actively managed mutual funds, taxable bond funds and Real Estate Investment Trusts.

 

MANAGING YOUR CASH FLOW

As a retiree, you not only need to consider what accounts you can put money into but also your strategy for taking money out. In general, it may make more sense to withdraw money from your taxable accounts first and pay the lower capital gains taxes rather than pay ordinary income taxes on IRA withdrawals. But a lot depends on your cash needs and your tax bracket. I'd talk to your tax advisor before making any decisions. It will be worth the effort to help ensure you have retirement income that's both tax-smart and secure.

Carrie Schwab-Pomerantz, CERTIFIED FINANCIAL PLANNER(tm), is president of Charles Schwab Foundation and author of "It Pays to Talk." You can e-mail Carrie at askcarrie@schwab.com. This column is no substitute for an individualized recommendation, tax, legal or personalized investment advice. To find out more about Carrie Schwab-Pomerantz and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.

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