As an investor making contributions to an individual retirement account (IRA), it is important to be aware of the specific rules pertaining to how IRA funds can be contributed, withdrawn, and taxed. While you may be aware of some of these requirements, a specific rule to be aware of is the Internal Revenue Service’s IRA aggregation rule.

Simply put, the Internal Revenue Service views the assets held in your combined IRAs as one account, not multiple accounts. As such, if you have multiple IRA accounts it is important to understand both the financial and tax implications and how the IRA aggregation rule may impact your accumulated wealth.

Roth IRAs vs Traditional IRAs

To start, let’s take a look at Roth IRAs vs Traditional IRAs and understand the differences in how income is contributed, taxed, and considered for the IRA aggregation rule.

With Roth IRAs, contributions are initially taxed, but investment growth and withdrawals are not. Roth IRAs also mandate an income threshold and such, investors earning more than an adjusted gross income (AGI) of $140,000 are unable to make further contributions to their accounts. Investors over 50 can also only contribute $6,000-$7,000 to their total IRAs, including both Roth and Traditional accounts. As contributions to these accounts have already been taxed, the IRS aggregation rule doesn’t apply to Roth IRAs.

With a Traditional IRA on the other hand, your tax benefit comes at the onset of your contributions, as your contributions are made pre-tax and subsequent account growth isn’t taxed until you withdraw those funds. For many investors, it is easy to accumulate multiple IRAs over time with varying balances. However, since all of the funds in those combined IRAs have been contributed pre-tax, they are in turn eligible for the IRA aggregation rule and will be taxed at the combined amount of all accounts.

Exceptions to the Aggregation Rule

It is important to note that inherited Traditional IRAs are not included in the IRA aggregation calculation and therefore, are not rolled into an investor’s existing IRA account totals or tax calculations. Similarly, spouses or joint filers are not subject to IRA aggregation and each investor’s IRA accounts are instead treated individually and not combined with their spouse’s account totals.

Aggregation Challenges

If all of your IRAs contain only pre-tax dollars, the aggregation rule and combined taxable income is fairly straightforward. Where the aggregation rule becomes more complex and complicated is when you have a combination of nondeductible and deductible contributions to multiple accounts. As IRA accounts are aggregated, both your deductible and nondeductible contributions will be combined into one total and your tax obligations will be calculated on a pro-rata basis.

Easing the Tax Burden of IRA Aggregation

If you find yourself with several Traditional IRAs, and your nondeductible contributions are significant, you may have the option to roll your IRAs into an employee sponsored 401(k), easing the tax burden of your combined accounts. As these backdoor Roth IRA conversions can be complex though, specifically if you have multiple IRAs, we suggest you consult with your financial advisor to determine if this option is applicable to your investments and fits your long-term investment strategy.

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The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision.

The attached information was developed by Threaded Marketing Group, an independent third party. Any opinions are those of the author and not necessarily Raymond James. Any information provided is for informational purposes only and does not constitute a recommendation.

There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or a loss regardless of the strategy selected.

Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.