IRA 101: The Individual Retirement Account
Saving for retirement can be an arduous task when considering the many curve balls life can throw: rising education costs, vehicle repairs, and ever-inflating prices. However, did you know that two secret accounts can make saving for retirement ever so more palatable?
Enter the traditional and Roth Individual Retirement Accounts, or IRAs for short.
You see, the Government wants you to save for retirement to enjoy a prosperous lifestyle once you have aged. So, what better way to incentivize people than by offering preferential tax treatment to those willing to partake?
Thus, with IRAs, the Government offers either a tax write-off now or a tax-free withdrawal down the road. The result is an incentive for the average person to save while accruing benefits that otherwise are underheard of: an upper hand on taxes for the layperson.
How they work
With IRAs, the Government allows you to save $6,000 a year if you are under 50 or $7,000 a year if you are over 50, the latter of which is higher to help those nearing retirement save a bit more or catch up on missed contributions earlier in life.
When contributing to a traditional IRA, you receive a tax deduction now. Then, when you are ready to withdraw the money, you pay taxes. The benefit is that any growth earned remains untaxed until then and that come retirement, you likely are in a lower tax bracket. (This assumes that tax rates don't go up or that you don't make more in retirement than you presently do.) Thus, you save money by deferring your taxes into the future!
However, with Roth IRAs, the script is flipped. Instead of waiting to pay taxes in the future, you pay them now. In return, you don't have to pay taxes on that money again, regardless of how much it grows!
IRAs and investments
The beauty of IRAs is that they are investable in various assets, including stocks, bonds, mutual funds, ETFs, money markets, CDs, options, and more. Therefore, you have the potential to grow your contributions substantially with time to outpace inflation through compound interest.
Nevertheless, as with all things in life, there are rules to know when using IRAs to save.
First, you must have earned income through work to save in an IRA, meaning that if you are retired or not working, you no longer can save new dollars in these accounts. (You can always continue to invest money in the accounts.)
Second, if you have a job that does not offer a retirement plan, you can always contribute to a traditional IRA and receive a current-year tax deduction. However, with Roth IRAs, income limits govern who can contribute to them so that high earners cannot utilize them. (See the IRS website for the income limits here.)
Additionally, with traditional IRAs, if you have an employer-sponsored retirement account and make over a certain amount, your contributions are not deductible. (See the IRS page on income levels for traditional IRAs here.)
Third, if you take money out of your traditional or Roth IRA before the pre-set retirement age of 59.5, you will be penalized by 10% of the amount (unless you have an exemption).
Fourth, once you attain 72 years of age, Uncle Sam requires you to withdraw funds from your traditional IRA since they are tired of waiting for their deferred tax dollars. (Their patience only goes so far!)
Lastly, other rules can apply to IRAs. If you have questions, please feel free to contact us!
Both traditional and Roth IRAs can be a great way to save for retirement. If you are unsure if an IRA could be a good option for your future, please reach out to us, and we would be happy to discuss how they could fit into your retirement plan. Stay safe and join us next week to learn about small business retirement plans on the LAA blog!