When planning for retirement, many Americans choose one or more types of individual retirement accounts (IRAs) to minimize taxes while maximizing their savings. An IRA is a long-term savings account that can be used to earn on and invest funds, and is a great alternative for people without access to an employer-provided retirement account, such as a 401(k).
Whether you’re considering opening an IRA or simply brushing up on the basics, here are key things to know, plus tips to help you make the most of your account.
What You Need to Know About IRAs
Who can open an IRA? Anyone can open a traditional IRA. This includes minors as well as people who already hold or intend to enter an employer-provided 401(k) account. It’s never too early—or too late—to begin saving for retirement!
How do you open an IRA? You have a couple of options, from depository institutions such as credit unions or banks, to a personal broker, an investment company, or an online brokerage.* Essentially, any of these can assist you with opening and maintaining your IRA, so you can make your choice based on needs, circumstances, and comfort level.
*With the rise of financial scams, be vigilant about where and when you provide your personal and financial information, particularly online brokerages.
How can I invest with my IRA? IRAs offer a wide range of investment options, including stocks, bonds, exchange-traded funds (ETFs), mutual funds, and, in certain cases, real estate. Depending on the size of your IRA, you may consider hiring a professional manager to invest your funds on your behalf.
What types of IRAs are there? There are advantages and drawbacks to the various IRA options you have, including:
- Traditional IRA – In a Traditional IRA, investments in the account are tax-deferred, but withdrawals in retirement are taxed like any other form of income.
- Roth IRA – Contributions to a Roth IRA are made after tax. However, earnings, including investment gains, are tax-free. There is a greater access to your Roth IRA funds without penalty, versus a Traditional IRA.
- Simplified Employee Pension (SEP) IRAs – In a SEP IRA, the sole contributions are made by the employer directly to an employee’s IRA, including self-employment. This is a useful benefit for a variety of business types.
- Savings Incentive Match Plan for Employees (SIMPLE) IRAs – This plan allows for employers and employees to both contribute to an IRA, often on a limited match scale.
- Self-Directed IRA (SDIRA) – In this type of IRA, account owners can directly invest their funds, for instance in stocks, commodities, or real estate.
What are the limitations of IRAs? IRAs are designed for retirement, so withdrawing funds before age 59 ½ generally results in a 10% penalty. There are some exceptions, such as higher education expenses or first-time home purchases, but these also have respective limitations.
Additionally, keep in mind that account owners are required to begin withdrawing from their IRA at the age of 73 in what are called required minimum distributions (RMDs). RMDs are treated as a form of income, so are taxable and can impact tax bracket placement.
IRA contributions must be made in cash, and the total amount you can contribute in a single year is limited based on your age and income level. Consult the IRS website and/or a tax consultant for more information about limitations.
Additional Tips for Maximizing Your IRA
Now that we’ve covered some of the basics, let’s address a few common concerns about how to utilize your IRA. Review the following tips and remember to consult a trusted professional about your goals and options!
Save Yourself Time & Money
IRA contributions, like any long-term savings, take time to compound. So it’s advisable to kickstart your IRA early—not only in the span of your professional earnings but also within each tax year. As one Morningstar contributor helpfully puts it, “Investors have until their tax-filing deadline—usually April 15—to make an IRA contribution if they want it to count for the year prior.”
So, it’s easy to put it off, “squeaking in their contributions right before the deadline rather than investing when they’re first eligible (Jan. 1 of the year before). Those last-minute IRA contributions have less time to compound—even if it’s only 15 months at a time—and that can add up to some serious money over time.”
In order to optimize your contributions during annual timeframes, consider automating them! Even if you don’t have your full amount ready, you can set smaller installments that will add up over the tax year.
Match When You Contribute to Where You Contribute
There are many misconceptions about what IRAs can and can’t do for you, depending on your age. Young professionals might put off establishing an IRA, for instance, given that they might want greater access to their funds that might be “tied up” in a retirement account. Older professionals might choose not to use an IRA because it will not have as much time to mature by the time they would want to use it.
Roth IRAs may provide a flexible solution in both instances. Roth IRA contributions and earnings can be withdrawn under certain circumstances without taxes or penalties, which may put a younger investor at ease. Similarly, an older contributor might utilize a Roth IRA to set aside funds not for themselves but for their children or other beneficiaries, who can inherit the account and take tax-free withdrawals, all while avoiding RMDs.
Investigate your IRA options. You may find that there is a better fit than you anticipated!
Keep Your Beneficiaries in Mind
If your spouse isn’t earning income, you may still be able to contribute to an IRA on their behalf. By doing so, you can potentially raise the threshold for contributions from one to two individuals per calendar year, effectively doubling your household’s contribution potential and boosting your shared savings.
Also, remember that IRA beneficiary designations override your will. Don’t set them and forget them—review them regularly, especially after major life events or changes to your estate plan. It’s also important to be proactive about how legal regulation changes may impact your plans. Keeping your designations current ensures your legacy is passed on as intended.
Before assigning beneficiaries, speak with a financial advisor. Depending on the relationship, IRA inheritance can come with different tax implications that are worth understanding ahead of time.
Final Considerations
IRAs are a smart addition to a long-term savings strategy—but like any investment, they come with risks. Earnings fluctuate, brokerages merge or disband, and the market goes through cycles. Always perform your due diligence before making a financial transaction and regularly review your risk tolerance with your funds.
As you prepare for the year ahead, think about your IRA goals and what steps you can take to grow your retirement savings. Every year counts when contributing to your retirement or setting aside funds for your family, and IRAs offer a number of resources to the savvy saver. Don’t hesitate to speak to a professional about your questions, concerns, and interests, and set up an account—or more than one—today!
Information contained in this blog is for educational and informational purposes only. Nothing contained in this blog should be construed as financial, legal or tax advice. An attorney, financial advisor, and/or tax advisor should be consulted for advice based on your circumstances.
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