Retirement planning is far from simple. Sometimes, it feels like you are speaking a different language from everyone else. From words like 401k and 403b to IRAs, it can be a bit overwhelming. The better you understand your IRA options, though, the greater your flexibility in managing your retirement investments becomes. These are a few key details and facts about IRAs you need to know.
Individual Retirement Accounts
First things first, what is an IRA? IRA is short for Individual Retirement Account. It represents a specific type of tax-advantaged investing account set aside for retirement savings. The varied types of IRAs allow improved flexibility and freedom for your retirement investing. The more you learn about your options, the more informed of a decision you can make about which type of IRAs best meet your needs and interests.
Before diving in too far, it is essential to understand that whether your contributions to an IRA are tax-deductible depend on a few factors, including accessibility to employer-sponsored retirement plans and your income. There are also limits related to how much you can invest in IRAs each year. Plus, funding limits can vary from one type of IRA to the next. It is wise to consider all options before choosing one over another so that you have a clear image of what each one will mean for your retirement savings.
As long as you are employed, whether self-employed or otherwise and under the age of 70.5, you can invest in a traditional IRA. That is, as long as you fall within the income limitations and abide by the maximum contribution limits for traditional IRAs.
If you have an employer-sponsored retirement plan you participate in, you may still contribute to a traditional IRA, but those contributions are not tax-deductible. The one upside of that, however, is that the earnings are tax-deferred as they grow.
With the traditional IRA, you may begin receiving distributions of payment at the age of 59.5 as long as you have had the account open for at least five years, and you must start taking out distributions by April 1 of the year after you reach the age of 70.5.
The costs of early withdrawals are high and include taxation and IRS penalties of 10 percent. You may, however, receive a loan from your IRA. It must be repaid within 60 days, though, or the same penalties for early withdrawals apply.
While Roth contributions are never eligible for tax deductions, the earnings on these investments grow tax-free. Investing in this type of IRA is, essentially, giving yourself the gift of tax-free income during your retirement. The limits for investing in Roth IRAs are usually equal to the limits of investing in traditional IRAs when it comes to income and investments.
Another benefit of the Roth IRA is that it offers more lenient rules regarding withdrawals. Anyone who anticipates retiring in a tax bracket that is larger than their current tax bracket might want to consider the post-retirement tax-benefits this type of IRA delivers.
Roth IRAs are also exceptional choices for people interested in leaving their heir’s tax-free income. In some cases, it can last throughout their lifetimes, according to Bankrate. You can also continue contributing to your Roth IRA even after reaching the age of 70.5, which is something you cannot do with a traditional IRA.
One more reason to give the Roth IRA a long, hard look applies to high earners or people who earn more than the limits for a Traditional IRA. You do this by making a contribution to a Traditional IRA that is not tax-deductible and then converting that IRA to a Roth IRA. You must also pay taxes on any gains made when the conversion takes place. Many refer to this is at the Roth Back Door. However, there are tricky tax considerations for this option, and you should obtain the advice of a tax professional before going down this path.
This type of IRA, while governed by the same contribution and income limit rules of other types of IRAs offers greater freedom when it comes to types of investments allowed. For instance, Roth and Traditional IRAs are often limited to the usual investment scenarios that include the following:
- Mutual funds
Self-directed IRAs offer an expanded list of assets in which you can invest, such as:
- Real estate
- Privately held companies
It offers investors more options but also comes with stricter regulations about how the money can be used in relation to those investments.
Short for Simplified Employee Pension IRA, these are employer-sponsored IRAs. The money in these IRAs gets contributed by the employer and offers a flexible, cost-effective option for employers who would like to help employees have retirement savings but are not able to contribute every year. The employee controls the retirement funds in an employee’s account. The employer makes contributions when possible and receives the tax deduction for the contribution.
This employer-sponsored plan is short for Savings Incentive Match Plan for Employees (SIMPLE) IRA. Best suited for small businesses that have fewer than 100 employees who earn at least $5,000 annually. The beauty of this plan for employees is that employers may make matching contributions or non-elective contributions.
IRAs might sound complicated. And specific rules abound for each different one. Working with a financial advisor and tax professional can help you maximize your IRA mileage so that you can get closer to your retirement goals.