Part of the challenge people face when planning for the future is figuring out exactly where to put their money. There are so many different plans out there that it can be confusing. This may cause people to just avoid the pain of trying to make a decision. One important strategy in your retirement planning is to take advantage of IRA accounts.
IRA Accounts – Flexibility With Many Options
IRA accounts have a tremendous amount of flexibility. You can open an IRA account on your own. It is an account you can easily contribute to and manage. IRA accounts should have strong consideration in any solid investment and retirement planning strategy.
There are 2 main IRA accounts you will hear about, so let’s examine them in detail and discuss the advantages and disadvantages of each. One benefit of IRA accounts right off the top is that you can open and fund one on your own without having to rely on an employer to provide it.
IRA Accounts – The Traditional IRA
The traditional IRA is the oldest of the various IRA offerings. To give you an idea of how far back the concern about retirement savings in the USA goes, the original IRA was part of the Employee Retirement Income Security Act (ERISA) of 1974. As long as you have earned income in a given year, you can contribute to a traditional IRA.
The Traditional IRA is used with pre-tax money. As long as you meet the criteria on the income limits, you can deduct the contributions on the state and federal returns and the money grows tax-deferred. When you take the money out of the account after age 59 ½, you pay taxes on the money at that time based on your tax bracket.
If you take out the money prior to that age, you would be subject to taxes and a 10% penalty. Once you reach age 70 1/2 , you can no longer contribute to a traditional IRA and you also have to start taking minimum distributions from your account.
The contribution limit is published on an annual basis by the IRS. Currently, the maximum contribution is $5,500 a year or $6,500 if you are 50 or older. That maximum counts for all your IRA accounts. So, if you have a traditional IRA and a Roth IRA, you can only contribute $5,500 total between both.
You can avoid being penalized on early withdrawal for certain criteria. First time home purchase, education, disability, medical, and health insurance expenses typically are exempt. However, realize that you will still have to pay tax on the money when you use it.
IRA Accounts – The Roth IRA
The Roth IRA was introduced in 1997 as part of the Taxpayer Relief Act of 1997 and is named for its chief sponsor, Senator William Roth of Delaware. The Roth IRA shares some similarities with the traditional IRA, but has some significant differences. The flexibility a Roth IRA offers has made it an extremely popular savings option.
The Roth IRA uses funds from after-tax dollars. You cannot take any tax deduction on contributions made to the account. However, the money grows tax-free. Once you turn age 59 ½, you can take the earnings out and pay zero taxes on the money.
With the Roth, you can always take out what you’ve contributed without penalty. Another advantage with the Roth IRA is that there are no mandatory distributions. If you reach age 70 and want to continue contributing to your Roth IRA, you can do so and not have to withdraw any of your money.
As mentioned, the annual limit applies the same to a Roth IRA as it does with a traditional. You can contribute to both type of IRA’s in a given year, but the total cannot exceed $5,500 (currently) between both accounts. You can avoid penalties on a Roth IRA early withdrawal based on the same criteria as a traditional IRA. Make sure you carefully check the current rules before making a decision.
IRA Accounts – Which One is Better?
With both IRA options having pros and cons to consider, some people struggle in deciding which type of IRA they should open. Both types are good savings vehicles for retirement. The basic rule of thumb is that if you expect to be in a higher tax bracket when you start to take withdrawals, you are better off with a Roth.
If you expect to be in the same or a lower tax bracket, you should go with a traditional. There are good arguments on both sides of the debate. However, with tax law always changing and the unpredictability of what the future may hold, it might be safer to go with a Roth IRA. I personally prefer the flexibility and the benefits of the Roth.
Like many other tax benefits, Congress is always lurking, threatening to reduce or eliminate the advantages of IRA accounts. Whatever you decide, just make sure you take advantage of an IRA account if you qualify. Anytime you can reduce your tax burden, you need to do it.
There are some other IRA options you might be aware of. Here are three other varieties on the IRA to be aware of:
This is an IRA you can set up for a non-working spouse. Both spouses can fund the account and you can set it up as a traditional or Roth IRA. The same rules and restrictions apply for taxation and withdrawal.
The MyRA was a recent offering from the government that was designed as an automatic savings vehicle and is structured exactly like a Roth IRA. In fact, the MyRA converts to a private-sector Roth IRA when the account reaches a total of $15,000. The MyRA is ultra-conservative since it invests in the going Treasury bond rate. The Department of Treasury has already decided to phase this program out. If you have one, you should convert it immediately.
While it was sold as a great way for young people to get their feet wet in investing, the returns on the account are very low and barely beat a high yield internet savings account. Most skeptics just view it as a way for the government to dump a lot of debt from treasury-issued bonds onto the unsuspecting public. Most young investors are better served in a regular Roth IRA since they can afford to take more risk with their money and take advantage of the long-term growth of the funds. Transfer your money if you have a myRA account.
The rollover IRA uses funds you have in another qualified plan. Most of the time you use this to transfer money from a 401K from a previous employer. This can be advantageous so you have greater control over the money and more investment options.
If you roll the funds over into an account with different tax treatment, such as from going to a traditional 401K to a Roth IRA, that would count as conversion and you would have to pay income taxes on the original contributions. Check with both providers if you pursue the Rollover IRA option since there is a 60-day rollover requirement if the funds are paid directly to you before the transfer.
IRA Accounts – Take Full Advantage
IRA accounts are an excellent savings vehicle. Unless you are a high earning individual, they should be a key component of your retirement plan. In our economic climate, you have to take advantage of all suitable options available. If you have an IRA, are you taking full advantage of it? If you do not have an IRA, please give it careful consideration. You can start very small with your savings if necessary. With an ever-changing retirement landscape, now is the time to start! If you are struggling with money management, check out my Financial Muscle Book series. It is a series of three e-books with the goal of helping you achieve financial fitness for life!