This post is an excerpt from The FinancialVerse – A Common Sense Guide for Your Money that was released on October 9, 2019.
The third of the Big Four tax breaks is the individual retirement account (IRA). An IRA is another structure that allows you to save money for retirement in a tax-advantaged way. It is different than a 401(k) plan. An IRA is an account set up at a financial institution that allows an individual to save for retirement with tax-free growth (a Roth IRA) or on a tax-deferred basis (a Traditional IRA). Like a 401(k) plan, there are restrictions on how the account must be set up, what types of investments are allowed, contribution limits, and how withdrawals can be accessed.
The three main types of IRAs each have different advantages:
Traditional IRA – Contributions are made with pre-tax dollars you may be able to deduct on your tax return, and any earnings grow tax-deferred until you withdraw them in retirement. Many retirees find themselves in a lower tax bracket than they were in pre-retirement, so the tax deferral means the money may be taxed at a lower rate.
Roth IRA – Contributions are made with after-tax dollars, and any earnings grow tax-free, with tax-free withdrawals in retirement, if certain conditions are met.
Rollover IRA – The IRS allows you to use a Traditional IRA account for money “rolled over” from a qualified retirement plan. Rollovers involve moving eligible assets from an employer-sponsored plan, such as a 401(k) into an IRA, when the regulations allow you to do so.
The maximum IRA contribution limit for 2019 is $6,000, with those people age fifty and older able to contribute an additional $1,000. Please note there are income restrictions on whether an individual can contribute to an IRA. Please consult your tax adviser for these contribution limits.
Whether you choose a Traditional or Roth IRA, the tax benefits allow your savings to grow, or compound, more quickly than in a taxable account.
Why You Should Consider an IRA
Many financial experts estimate that you may need up to 60 to 85 percent of your income to support your financial needs in the Fulfilling Stage. An employer-sponsored savings plan, such as a 401(k), might not be enough to accumulate the savings and generate the income you need. Fortunately, in many circumstances, you can contribute to both a 401(k) and an IRA, subject to the mandated income restrictions. An IRA can help you:
Supplement your current savings in your employer-sponsored retirement plan.
Gain access to a potentially wider range of investment choices than your employer-sponsored plan.
Take advantage of potential tax-deferred or tax-free growth.
Try to contribute the maximum amount to your IRA each year to get the most out of this savings plan. Be sure to monitor your investments and make adjustments as needed, especially as retirement nears and your goals change.