One of the best things you can do for your future is to start saving for retirement.
And when you save early and often, you’ll get the biggest finances results thanks to compound interest over time.
So if you’re looking for an account that’s easy to set up, an Individual Retirement Account (IRA) is a good place to start. Just about anyone can open an IRA, and there are a number of brokers and banks that can help you get started.
Read on to learn about the types of IRA that are out there, and what you can expect when you use one to save for retirement.
How to open an IRA
Even though there are different types of IRA plans, opening them are fairly straightforward. Especially if you stick to a Traditional IRA or a Roth IRA.
Most banks offer IRAs, and all of the major online brokers offer IRAs. One of the easiest places to get started is Betterment, which allows you to open a low-cost IRA as long as you commit to investing at least $100 per month.
For the most part, you just need to be ready with the following information when you go to a bank or broker to open an IRA:
- Social Security number
- Phone number
- Bank account information so you can fund the account
Once you’ve figured out how much you can invest and where to put your money, you can choose from the following different types of IRA.
This is one of the easiest retirement accounts to open. Almost anyone with earned, taxable income is allowed to open and contribute to a Traditional IRA. There are no income limits associated with this type of IRA either.
It’s also worth noting that it’s possible for you to make contributions to your spouse’s IRA if your partner stays at home and doesn’t have any earned income.
However unearned income, like income from dividends and rentals, doesn’t “count” when it comes to opening and contributing to a Traditional IRA. So double-check to make sure your income qualifies before you get started.
Remember, a Traditional IRA is a tax-deferred account, meaning that you contribute with before-tax dollars. This amounts to a tax deduction, reducing your overall taxable income.
Although you get more bang for your buck now with a Traditional IRA, you’ll have to pay taxes later when you withdraw.
The good new is you can contribute to a Traditional IRA even if you have another retirement account at work. However, the amount that you can deduct might be reduced if you or your spouse contributes to another retirement account elsewhere.
Required Minimum Distributions
One of the quirks of Traditional IRA retirement accounts is that you must start taking required minimum distributions (RMDs) after you reach age 70 ½.
The government uses a formula that considers your income, the size of your retirement account, and your life expectancy to determine how much you are required to withdraw each year.
Since you have to pay taxes on the amount you withdraw, RMDs can have serious financial consequences.
Therefore, when you reach retirement age, it’s a good idea to speak with a financial professional about the best way to plan your distributions. And, how to make them work most effectively with your Social Security benefits.
The Roth IRA is a little different from the Traditional IRA.
Instead of getting a tax deduction for your contributions, you use after-tax dollars. This means you pay taxes first, and then you contribute to your retirement account.
Even though you have fewer dollars in your pocket today, the future gains could be huge.
That’s because, with the Roth IRA, you don’t pay taxes when you withdraw the money later. So if taxes go up down the road, or if you retire in a higher tax bracket, that translates into savings for you.
Essentially, since you’ve already paid taxes at the lower rate, you don’t have to worry about paying taxes again later.
Unlike the Traditional IRA, though, the Roth comes with an income restriction. Your ability to make contributions phases out and then disappears at certain income levels.
However, the phaseout changes along with inflation. So double-check before you make contributions.
On the plus side, you don’t have to worry about RMDs with a Roth IRA.
Contributions to an IRA
No matter which of the two main IRA types you choose, your contribution limit is the same for the tax year. You can only contribute $5,500 for tax years 2015-2017. That’s the same across all IRAs.
So if for example, you contribute $3,500 to a Traditional IRA, you still only have $2,000 left that you can contribute to a Roth in that year.
You can make a contribution to your IRA any time throughout the tax year, even up to tax day of the following year. Therefore, you can make a contribution for the tax year 2016 until up to tax day in 2017.
However, you have to be very clear that you are making a “previous year” contribution if you make the contribution after January 1.
In future years, the contribution limit is likely to go higher. Since the IRS creates contribution limits based on inflation, check to see if you can increase your contribution each year.
Withdrawals from an IRA
In general, you aren’t supposed to withdraw money from your IRA until you are at age 59 ½.
But if you decide to withdraw early, you are required to pay tax on the withdrawal if it’s a Traditional IRA. And, for both Traditional and Roth types of IRA, you are charged an additional penalty for early withdrawal.
It is possible, however, to “borrow” from your Traditional IRA without paying the penalty. As long as you return the money quickly,
The Roth IRA has an interesting quirk that allows you to withdraw your own contributions without penalty, though.
So, if you have contributed $4,000 this year, and the earnings on that are $300, you have $4,300 in your account. Because the money is put in after-tax, you can withdraw up to $4,000 without penalty. Once you dip into your earnings, though, you are subject to the penalty.
Types of IRA accounts for the self-employed
One of the perks of the IRA is that it’s easy to open and almost anyone can open one. If you have your own business, you can easily open an IRA and save for retirement.
However, if you are worried that the contribution limit is too low to help you reach your goals, there are other IRAs available to business owners. You can open a SEP or SIMPLE IRA and contribute more each year.
If you are self-employed, look into these options. Although they require a little more planning to set up, and you might need to open up contributions to your employees, they can be great tools for business owners hoping to sock away more for retirement.
At the end of the day, it’s important not to fall behind with your retirement planning. And if your employer doesn’t offer a retirement plan (and maybe even if it does), consider opening an IRA.
The earlier you start saving for retirement, the better off you’ll be.
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