Everything You Need to Know About Individual Retirement Accounts (IRA)
What Is an IRA And Do You Need One?
An IRA is an Individual Retirement Account designed to make your money work for you. IRAs aim to secure your financial freedom as you plan your retirement.
Like many investment accounts, an IRA includes a variety of benefits such as tax advantages. While a standard savings account is great, investing your funds into an IRA helps your money grow rapidly—even from just one contribution.
There are several types of IRAs you can choose from to suit your specific money goals and financial plans.
In this blog article, we’ll explore everything you should know about IRAs, and how to get started investing for a financially successful future.
Everything You Need to Know About IRAs
Learn the types of IRAs and their distinctive purposes
Understand the cons and pros of having an IRA
Discover how to open and manage an IRA
Which Type of IRA Is Best For You?
IRAs are mainly used for contributing your income upwards of $7,000 depending on your age, your annual income (combined if you’re married) and your current retirement savings plan.
Unlike a pension or employer-based 401(k), investing in an IRA gives you the chance to grow your wealth at a much quicker rate, along with other benefits such as diversifying your investment portfolio and saving on your taxes.
There are seven types of IRAs:
Traditional IRA: The most popular IRA where your money grows tax-deferred as you contribute pre or after-tax dollars. Traditional IRAs work best for individuals who expect to be in a lower tax bracket in retirement.
Roth IRA: The second most common IRA where you contribute after-tax dollars so your money grows tax-free. Roth IRAs work best for people who anticipate being in a higher tax bracket in retirement.
SIMPLE IRA: The Savings Incentive Match Plan for Employees are similar to 401(k)s and traditional IRAs, except you can choose which financial institution you’d like your account with. SIMPLE IRAs are best for individuals who work in small companies (usually 100 employees or less), and/or want to contribute less but still have access to standard benefits.
SEP IRA: The Simplified Employee Pension is a form of the traditional IRA where employers establish and fund the account, and receive tax benefits. SEP plan gains grow tax-free, with the distributions taxed in retirement. These IRAs work best for small business owners or sole proprietors who want to move around those large startup costs for an IRA but enjoy the hefty earnings.
Self-directed IRA: This IRA follows the rules of either a Roth or traditional plan, and is best suitable for experienced investors who want to invest in vehicles beyond retirement, such as real estate, precious metals and nontraditional businesses.
Nondeductible IRA: This plan works best for those who exceed the contribution limit, either by earning a higher income and/or already having a separate retirement plan like a 401(k).
Spousal IRA: This IRA is best for married couples who either both earn a low-income, or one spouse less to no income. The couple can share a traditional or Roth account or create their own.
Each IRA has its own set of rules and benefits, so picking the best one for you comes down to your financial needs both now and in the future.
Con and Pros of IRAs
There are general cons and pros of each IRA, but let’s take a look at the comparable pitfalls and benefits of both traditional and Roth IRAs.
Cons of a traditional IRA:
Contribution limits are low with low to no tax deduction benefits (based on you and/or your spouse’s income).
10% penalty for early withdrawal before 59 1/2 years old.
Pros of a traditional IRA:
Your money grows tax-deferred until retirement.
Includes bankruptcy protection with adjustments for inflation every three years.
Cons of a Roth IRA:
Taxes on gains are due upfront and may have the potential to cut into savings.
Benefits may not kick in if your tax rate is lower than you expected in retirement.
Pros of a Roth IRA
Because you pay taxes early, your money grows and remains tax-free during retirement.
You can make early withdrawals of your contributions, not your gains, any time without penalty.
How Do You Open An IRA?
Anyone can open an IRA, you’ll just need to find a bank, Financial Planner or robo-advisor service that you trust to work with you.
If you would like a service to completely manage your investments with little human interaction, a robo-advisor may be the way to go.
If you would rather have a more hands-on approach, working with an expert Financial Planner may be what you need to get the most return from your investments.
While the IRS doesn’t require a minimum balance to open your own IRA, some services do ask that you contribute a certain amount to get started.
Review your financial goals and current income to find the right percentage to tuck away into your IRA.
Even if you only have a small sum to contribute right now, an IRA can help your money grow exponentially, and provide financial protection when you need it.