An individual retirement account, or IRA, is a specific type of savings account designed for retirement savings. IRAs come in several forms, but all IRAs offer tax advantages that make it easier to save money for retirement. An IRA is a wise choice if your employer doesn’t offer a 401(k) plan, but it can also be used in conjunction with a 401(k) to supplement your savings and give you greater tax advantages. Jan Gleisner, an experienced investment advisor San Diego residents trust for reliable advice, offers this overview of the two primary types of IRAs and how they work.
Because IRAs are tax-advantaged plans, there are rules for how they can be used. One of the most important things to understand is how much you’re allowed to contribute to an IRA. For 2018, the maximum you can contribute to your IRA is $5,500, or $6,500 if you’re 50 or older. If you have two or more IRAs, the limit is combined across all accounts. If you make any withdrawals from an IRA before the age of 59 1/2, you may trigger income taxes and a 10 percent early withdrawal penalty.
How a Traditional IRA Works
With a traditional IRA, your contributions are typically tax-deductible for the year in which they were made. A traditional IRA is usually recommended when you believe your current tax rate is higher than it will be once you retire. When you make withdrawals during retirement, the money will be taxed. Anyone can contribute to a traditional IRA, although the amount you can deduct on your taxes is limited by your income.
How a Roth IRA Works
With a Roth IRA, your contributions have already been taxed. Contributions to a Roth IRA aren’t tax-deductible, but when you make withdrawals in retirement, you won’t be taxed at all. If you believe your tax rate will be the same or higher when you retire, you may benefit more from a Roth than a traditional IRA. To qualify for a Roth IRA, your income must be below a specific threshold. For example, if you make less than $189,000 with a filing status of “married filing jointly” or “qualifying widow,” you can make the full contribution. With an income of $189,000 to $198,999, your contribution is reduced. With an income of $199,999 or more, you’re not eligible for a Roth IRA.
Benefits of an IRA
An IRA allows you to contribute to your own retirement savings if you don’t have a retirement plan available through your employer or you already max out your annual contributions to a 401(k). Depending on the type of IRA you choose, your investment grows tax-deferred or tax-free. An IRA also allows you to invest in a wide variety of financial assets such as bonds, ETFs, stocks, and mutual funds. There are even more options in a self-directed IRA, such as commodities, real estate, and peer-to-peer loans. While there’s a hefty early withdrawal penalty prior to age 59 1/2, there are exceptions to this rule, allowing you to make withdrawals to buy a first home for yourself, children, or grandchildren or to fund college expenses for the same family members.
It’s never too early to start thinking about retirement planning. San Diego, CA, residents who want to get started building their nest egg and need information about IRAs or any other aspect of retirement planning should contact Jan Gleisner today at 858-337-2385.