An Individual Retirement Account, or IRA, is a type of retirement savings plan known for coming with several tax advantages. IRAs are a reliable investment vehicle that give people more flexibility over how much they may contribute and withdraw financially to their retirement funding.
For those reasons alone, if you’re looking to plan ahead and save for the best years of retirement ever, then an IRA is the plan for you. First, take a look at some IRA specifics — even though they’re very straightforward in structure, there are some questions to ask yourself. How many types of IRAs are there? What are the pros and cons? Are there age limitations or penalty fees?
An IRA takes a few forms with a few differences in their tax breaks, features and contribution limits.
The Traditional IRA. The fundamentals of what IRA saving so beneficial are in the Traditional IRA. This account is tax deferred, so the money you contribute to your IRA isn’t taxed until after you withdraw your funds. That means if you begin your IRA at age 30, and plan to retire at 65, you won’t pay any taxes on your savings for another 35 years. With a Traditional IRA, you can keep contributing as late as age 70, and begin withdrawing as early as 59 1/2. Withdraw earlier, though, and incur penalty fees. In 2013, the contribution limit to a Traditional IRA is $5,500 ($6,500 is the “Catch Up” limit for people age 50 and older, according to the Internal Revenue Service).
The Roth IRA. With a Roth IRA, rules differ than that of its traditional counterpart. Here, account holders are taxed when they contribute to their IRA, instead of afterwards at withdrawal. This is a better arrangement for people who like to get their taxes out of the way first knowing that the funds they withdraw upon retirement comprise the full net amount of their savings. The contribution limit is also $5,500. Plus, you’re allowed to withdraw interest (not contributions) from your account before 59 1/2, penalty free.
SEP IRA. The Simplified Employee Pension IRA is an option if you’re a business owner looking to provide a retirement plan for your employees. It’s also a viable savings plan for self-employed people and their spouses. You can contribute up to 25% of your net income to this IRA variation.
Self-directed IRA. This IRA “directed at the self” allows you to invest your IRA contributions into assets not government registered. According to USA Today, funds from a self-directed IRA can be used towards a mortgage, or the purchase of rental property
Every banking product has its benefits and drawbacks including IRAs.
Tax breaks. Any tax deferment, no matter when it happens, is enough to make an IRA a worthy investment. Remember — Traditional IRAs are taxed at withdrawal, Roth IRAs, before withdrawal. The important thing to keep in mind is that an IRA is not tax free, just taxed at a specified moment depending on the account you choose. Some IRAs also allow you to make deductions off your contributions, meaning you pay fewer taxes during that given year.
Funds can be passed on. With a Roth IRA, savings that won’t be used after retirement can be inherited by your heirs.
Flexibility. IRAs come with fewer limitations and restrictions than other retirement plans, and they can be easily used towards other savings accounts. Your IRA funds, for instance, can be deposited into an IRA CD, where you’ll benefit from the high interest payout and low-risk security built into a certificate of deposit.
Penalties and contribution caps. The financial freedom IRAs can give don’t come without some restrictions. Contributions to an IRA are not unlimited, even if you’ve got the funds to do so. If you’d like to deposit more than $5,500 in a single year into your Roth, you can’t. This can hinder how much you’d like to save for retirement. Furthermore, the early withdrawal rule is a big no-no. Say you’ve decided to retire early, at 55; if it’s not 59 1/2, you could have up to 10% of your savings removed as a penalty for withdrawing your IRA savings too soon.
Consider all your options. Do you prefer your savings taxed now, or at retirement? What kinds of investments are you looking to make? Is your IRA designed as a primary, or supplementary, retirement savings? And most importantly, what age are you aiming to retire at? These are critical considerations anyone must make before starting up an IRA. If it’s a Roth you’re looking at, a host of sources on the Web can produce a Roth IRA calculator that can help you configure your savings potential based on your current age, projected retirement age, estimated investment contributions, estimated inflation rates, and more.
GoBankingRates.com also provides many new resources examining IRAs and how one can work for you. By planning now, you’ll be well prepared financially for when retirement arrives.