An IRA might be the best money jar you’ve ever seen.
Planning for retirement is probably one of the most confusing jobs that you’ve ever taken on. There are so many choices to make, and so many so many questions that you’ve probably got. For example, what is an IRA account, and why do you need one?
There’s so much more to retirement planning than tucking money away into a savings account. An IRA is one of many means for improving the way that you save. It’s a great idea for a lot of people, and it can work for almost everyone.
An Individual Retirement Account, called IRA for short, is an account that you can contribute to throughout your working years. Its sole purpose is to help you save more money for retirement than you otherwise could. Unlike an ordinary savings account, your IRA contains investments, perhaps stocks, bonds, and mutual funds. When you add money to your IRA, the money is distributed to your investments.
IRAs offer tax breaks, which are a big part of their appeal. There are tax advantages to saving money in an IRA instead of just in a savings account, brokerage account or your mattress…
When you save money for retirement in an IRA, you get to keep more of the money yourself and pay less in taxes overall — either when you invest the money or when you withdraw the money.
IRA accounts are similar to 401ks. They are both ways to save, invest and pay less in taxes. The main difference between an IRA and a 401(k) is that the latter is an employer-sponsored program that in many cases comes with the benefit of contribution matching. With an IRA, you’re in charge of the plan.
If you are unsure whether or not you need an IRA, you might try doing a reliable retirement calculator. Seeing exactly how much money you will need for retirement can be a powerful motivator. Just make sure you use a calculator that enables you maximum control over the inputs. You want to know how much YOU will need for retirement — not how much the most frugal or spendiest household in town needs. The NewRetirement retirement calculator wins awards for being detailed and easy to use. Best of all, it saves your information so you can make updates over time.
Cons: There are a few drawbacks to IRAs.
- First, once you contribute, your money is expected to stay there. So much so that a withdrawal comes with steep penalties. You can access it if you need to, but it will come at a price.
- Another drawback is that there are restrictions. Not everyone can qualify for every type of IRA. But if you meet the eligibility restrictions, it’s a good way for you to build up retirement savings.
Pros: IRAs are a great way to save for retirement.
- As mentioned above, the real benefit of an IRA is that you are paying less in taxes.
- And, while it might be considered a drawback, the fact that it is difficult to access the money to use for any other purpose beyond retirement can actually be a huge benefit. IRAs make sure the money is saved for its intended purpose — retirement — not a car or other temporary need.
IRAs come in different forms. There’s the traditional IRA, Roth IRA, SEP IRA and the SIMPLE IRA. Each one serves a different purpose for different financial circumstances.
Traditional IRA: A traditional IRA is the basic tax-deferred account. Your contributions are made pre-tax, and all of your dividends are untouched by taxes until you retire.
SEP IRA: A SEP IRA is the same as a traditional IRA, but it’s designed specifically for people who are self-employed.
Roth IRA: A Roth IRA is different from a traditional IRA in that you pay taxes on the front end, not later. Your savings grows without being taxed, but there’s no tax break when you contribute. Some people enjoy the fact that paying taxes now means no taxes on withdrawals later. You can only contribute to a Roth IRA “if you have earned income from a job,” says Kiplinger. That’s not a problem for most people. But for some, it can be.
Simple IRA: The SIMPLE IRA is another special program, but this one is designed for employees of small businesses and some self-employed people. Like a traditional IRA, contributions are tax deferred. But where the SIMPLE IRA differs dramatically from a 401(k) plan is that employers are required to make a contribution on behalf of the employee, even if the employee doesn’t contribute.
Virtually everyone qualifies for some IRA plan.
Individual retirement plans work for almost anyone because there are so many different types of IRA programs. There is an IRA for everyone. Once contributed, your money isn’t taxed every year, so CNN Money says that it doesn’t get whittled away a little at a time, year after year. Taxes do come into play later on, once you’re ready to start making withdrawals. But you can control those costs by taking only what you need when you need it.
The government does limit how much any one person can contribute. So once you make the decision to open an IRA, know that there will be limitations on it. But once you pass the age of 50, you get a break. In 2016, the IRS says that people over the age of 50 can contribute as much as $1,000 more than the usual limit.
If you have a SIMPLE IRA, $3,000 in catch-up contributions is allowed, making the yearly contribution limit $12,500. The IRS explains that catch-up contributions are due at the same time your yearly taxes are due.
They sound like a great thing, and for many people they are. But they aren’t perfect vehicles for retirement saving. That’s why most financial advisers tell clients to diversify as much as possible. Some mistakes can cost you, but there are usually ways to avoid them.
One of those mistakes is contributing at the last minute for the year. When this happens, you lose your yearly compounding, which can total a lot of money. Skipping Roth contributions because you made too much money is another mistake, says Bankrate. It might seem unavoidable, but it’s not. Through a nondeductible IRA, you can make your contributions. Later, you can convert that into a Roth.
Failing to take distributions form a traditional IRA once you reach a certain age is another misstep, says Bankrate. You’ll face penalties for not withdrawing, which makes sense because that’s when Uncle Sam gets his cut. So when you reach age 70 1/2, it’s time to take those distributions. There are other possible slip-ups that an IRA investor might make, and your financial adviser can help.
An IRA account is rarely a bad idea for anyone. There are several different plans and different ways to save, and you can find a plan that fits your income even if you’re a high earner. You can choose one that taxes up front or when you take distributions. And you can even find an IRA if you’re self-employed.
The important thing is taking advantage of the years when your money sits undisturbed so that it can grow. Once in an IRA, it doesn’t face taxes so the amount that you save grows faster than any savings account ever would.
Opening an IRA account is similar to opening almost any other kind of financial account.
- Perhaps the hardest part of opening an IRA is finding the will to do so. One way to get motivated is to do an online retirement calculator. Just make sure you use a reliable one. The NewRetirement retirement calculator is detailed, but easy to use. It will help you imagine your retirement and show you exactly how much you will need to live the lifestyle you desire. Knowing this number can really motivate you to save efficiently.
- You want to start by choosing a financial institution. You can open an IRA account at a bank (your local bank or a national chain), mutual fund company, roboadvisor or brokerage firm.
- When selecting a firm, be sure to look at the fees you will pay. These can vary widely and can really add up.
- Once you have selected your financial institution, you will fund the account — transfer the money in. Ideally you can maximize the amount you save. In 2016 you can put in up to $5,500 a year or $6,500 each year if you are age 50 or older.
- If you have other retirement savings accounts, you might consider rolling them over into one account to make money management easier.
- Then you will want to select your investments.
