Saving for retirement is a very important thing. There are many different options available to help make saving an easier process. With all of the terms and different plans out there, it’s difficult to understand which plan is best; or even what each plan does exactly. IRAs are just one of the plans a person can participate in to save for retirement.
What is an IRA?
An IRA is an Individual Retirement Account. By design, the IRA is meant to help people save up for retirement by offering two kinds of tax breaks upon meeting qualifications. The first tax break allows for an individual to put *$6,000 ($7,000 if 50+ years old) each year into the IRA, up until the age of 72. The money placed in the IRA is exempt from taxes until he/she begins to take money out of it. The second break, if one qualifies for it, allows the account owner to deduct IRA savings from his/her current income. Generally, in order to qualify for the second tax break, the individual must not be covered by any other retirement plan (pension, 401k, 403b etc.) or have a Modified Adjusted Gross Income below *66,000/year ($105,000/year if married filing jointly or qualifying widow(er)).
*Monetary requirements for IRA qualification and contribution limits are adjusted from year to year. Updated figures are provided on the IRS website.
IRA Basics
Anyone with a job that provides taxable earnings, is eligible for the IRA. The most beneficial aspect of the IRA is that the money in the account is saved without being declared as income on the year’s tax return. This allows for the money to gain interest faster than a normal savings account. The account is set up through a “custodian”; a bank, mutual fund, insurance company, or brokerage, as per the requirements of the United States Treasury Department. Once the IRA is set up, it can be moved from one institution to another. In order for the IRA to count for the year, it must be set up before April 15.
IRAs do not need to be contributed to every year. It is advised, however, to contribute every year if possible in order to gain the most out of the account. The fiscal year of the IRA follows the same time line as tax deadlines. Although there are different ways of investing the IRA, the key is making sure to choose something that will allow the money to grow. The IRA custodian may prove to be a valuable source of advice as to which option is best for the individual. Historically, stocks have been the go-to choice for growth potential. However, recent turbulence in the stock market has a number of investors questioning this route. Merely placing the money in a savings account offers minimal growth.
Once money is placed in an IRA, it must remain in the account until the individual is at least 59½ years old. The money can not be touched before then unless there is a qualifying emergency. To a young person just starting out in the working world, it may seem like a lofty commitment. It is better to start an IRA as soon as possible to allow for maximum saving time to prepare for the future, especially in the current economy. The IRA can always be adjusted or moved to a different institution if need be.
Types of IRAs
There are a few different types of IRAs. The information above details the terms of the Traditional IRA. Below are descriptions of the other types:
Roth IRA: This type of IRA is similar to the Traditional, the difference being that contributions are placed into the IRA from earnings after they are taxed, and will not be subject to a tax upon withdrawal. This kind of account must be held for at least five years. Those eligible for the Roth IRA are required to have a Modified Adjusted Gross Income below *$129,000 ($198,000 if married filing jointly or qualifying widow(er)).
Individual Retirement Annuity: This type of IRA is created with the help of a life insurance company. The parameters match that of a Traditional or Roth IRA, however, the terms are set under a special annuity contract.
Simplified Employee Pension (SEP-IRA): Similar to the Group IRA, with the addition of contributions by the employer up to 25% of the annual salary or $58,000.
Savings Incentive Matching Plan for Employers IRA (SIMPLE-IRA): This IRA is used by small businesses. The way it works involves employees contributing up to $13,500 per year. The employer then has the option to match a part of it.
Spousal IRA: Although spouses cannot open a joint IRA, each individual can open their own account. By having two separate IRAs you can claim double the tax deduction. Couples can defer paying income tax on up to $12,000 ($6,000 contribution each), which can increase to $14,000 when each member of the couple turns over 50 years old. In addition, a working spouse can contribute on behalf of a spouse who does not earn any income.
Rollover (Conduit IRA): A Traditional IRA that also receives contribution from a retirement plan. There is no limit on the amount of money transferred.
Inherited IRA: This is a Traditional or Roth IRA that is given to the beneficiary (not spousal) of an owner that has passed away. The person receiving the IRA will be given the money five years after the death of the owner. It is not eligible for tax deductions or rollover.
Education IRA (EIRA): This type of IRA is not actually an account for retirement. It is used to pay for higher education. The EIRA is not tax deductible but the money can be withdrawn without penalty. The beneficiary of the account must be below the age of 18.
Author: Ben Michaels