Individual retirement accounts help workers, especially those without access to employer-based plans, save for retirement. Anyone with earned income from a job claimed for tax purposes or who has a spouse with earned income can open and contribute to an IRA. Lawmakers designed these accounts to promote retirement savings and receive big tax savings, but added restrictions to discourage early withdrawals, making it harder to raid your life savings.
The annual maximum contribution for an IRA in 2019 is $6,000, or $7,000 for savers over 50 years old. These are increases from last year’s contribution limits. The contribution limits typically go up every year, although that’s not guaranteed.
There are two basic types of IRAs. Below are the general features of each, but there are more details you will need before making a decision on what’s best for you.
- A traditional IRA, which offers a tax deduction for the tax year in which the contribution was made. When you take funds out of the account to spend in retirement, these pretax contributions and earnings are treated as income in the year you take the distribution. This is good if you expect to be in a lower tax bracket when you retire. You must begin taking distributions in the year you reach age 70 1/2, although you can start taking money without penalty at 59 1/2.
- A Roth IRA, which gives investors a chance to invest money after taxes and take the contributions and earnings out tax-free in retirement. Contributions to Roth IRAs are made after taxes are paid, so there’s no deduction. However, the contributions grow tax-free: If you wait until you’re 59 1/2 to withdraw funds, earnings will not be taxed. But there is an exception: You can withdraw your principal or the amount you invested at any time penalty-free.
The tax advantages of IRAs make the accounts a powerful incentive to save for retirement. The earlier you start contributing to an IRA, the more money you can potentially make due to the benefit of compound interest. The longer your money is invested, the more you can harness the power of compounding: consistent saving coupled with a reasonable rate of return over a long period of time.
IRAs can be opened online or in person at most financial services providers: banks, credit unions, brokerage firms, mutual fund superstores or discount brokerages. Look for online educational materials and in-person guidance. Consider fees and the service you get for them.
IRAs can hold a variety of instruments—certificates of deposit, U.S. Treasuries, stocks, bonds and annuities. When you leave an employer, you can roll your 401(k) into an IRA without tax or penalty.
IRAs offer big tax breaks, making them ideal for socking away cash for your retirement. You can contribute funds to an IRA anytime throughout the year, and even after the year has ended, you can still add to the previous year’s IRA as long as you do this by the April tax deadline.
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