Last week we learned that anyone who plans to retire anywhere around the year of 2056 will need a whopping $2.3 million to do so comfortably according to CNN That’s equivalent to $870,655 in today’s standards. I’m still trying to wrap my head around that! We then went into the importance of starting to plan at an early age and some ways to go about it. I wanted to focus on Individual Retirement Accounts this week. These are perfect for people who are in jobs that do not offer retirement plans, self-employed individuals, and even those who are participating in employer sponsored plans but just want to get ahead of the game.
There are a few different types of IRAs to choose from. You have Traditional, Simple, SEP and Roth. The benefits and requirements vary amongst them all; however, they ultimately have the serve the same purpose. An IRA is a tax- sheltered account specifically designed for retirement savings. IRAs allow for each account registrant to make their own selection of investments, including stocks, bonds, and mutual funds (other investment types may be permitted depending on the financial institution). These accounts can be established at not only investment firms but also local banks, making it just that much easier to get started.
The only requirements for opening an IRA is that you are under the age of 70.5 and are currently earning income. If you can check the box on those two conditions, you’re ready to go! The other important thing to consider is that the intent is to encourage people to take control of their financial destiny, by saving more for retirement. We know that Social Security checks will one day be a thing of the past so as an incentive for people to take onus for their post retirement circumstances/needs , the government offers tax-sheltering.
Well let’s get to it.
Individuals
Traditional IRA- The benefits of this account type is that taxes are deferred on all contributions plus and earnings and dividends that accumulate within the account, until you take a distribution. If the account is deductible, contributions can be deducted from your overall annual tax bill. Nondeductible accounts unfortunately do not offer this option. Eligibility for a deductible account is dependent on the account owner’s personal tax circumstances. There are penalties for taking withdrawals from this account type prior to retirement age (currently 66). On the flip side, required minimum distributions (RMDs) must begin at the age of 70.5. These are only required so that the owner of the account can gradually start to pay taxes on each distribution.
ROTH IRA- Contributions into this account type are after-tax, which means that earnings and dividends grow “tax-free.” Because taxes were withheld prior to the contribution, the distribution is not taxed. Unlike the Traditional IRA, this account type does not have any penalties for taking distributions before retirement age (still subject to 10% penalty if taken before 59.5)
Small Businesses or Individuals
SEP IRA- This account type is designed specifically for the self-employed or small business owner. Unlike those previously discussed, employees do not contribute. Instead, contributions are funded by the employer. Contributions are tax deductible to the individual or business, and again no taxes are withheld until a withdrawal is made.
Simple IRA- The “SIMPLE” in Simple IRA stands for Savings Incentives Match Plan for Employees. This account type is very similar to the SEP IRA. The only difference is that this SIMPLE IRAs allow contributions from both the employer and the employee. In fact, the employer is actually required to make contributions on the employee’s behalf.
So as you can see there are many alternative to your typical Defined contributions plans ( 401 k , 403 b, etc). For more details, the best place to get the more accurate information is at IRS.gov.
Until next week…
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