If you are thinking about saving for retirement, you probably know that an Individual Retirement Account (IRA) is one of your options. But what exactly is an IRA, and is it right for you? Certified Financial Planner Paul Fain recently answered retirement account questions on WBIR’s Sunday Money.
PAUL, LET’S REVIEW – WHAT ARE THE MECHANICS OF AN IRA?
An IRA is an account in which you sock away money for your future retirement. Depending on the type of IRA you have, you will either have tax-free or tax-deferred growth.
- Traditional IRAs offer tax-deferred growth and maybe tax-deductible. This means you pay taxes on your savings and earnings when you withdraw the money (ideally, when you retire). So, at tax time, if you’re eligible, you can deduct the amount you save from your income, so you pay less in taxes now.
- With a Roth IRA, you can’t deduct your contribution from your income. But when you retire, you won’t pay taxes on the money with you withdraw from the Roth IRA. Your contributions into the account are post-tax; meaning, you’ll pay income tax on the money you put into the account. But that money will grow tax-free.
ROTH VS. TRADITIONAL IRA: WHICH IS RIGHT FOR YOU?
You need to consider several of the factors:
- The general rule of thumb is, if you’ll be in a higher tax bracket when you retire, you should pick Roth. If you’re in a higher tax bracket now, you should go with traditional.
- Keep your retirement savings tax diversified, meaning you have accounts that will be both taxable and tax-free when you cash out in retirement. For example, tax-deferred 401(k) plan + Roth IRA if you are eligible.
DESCRIBE THE ELIGIBILITY RULES FOR IRAs.
- Not everyone is eligible for a Roth IRA. If your income is over a certain amount, you might not qualify.
- Traditional IRAs have eligibility requirements, too. You can’t deduct your contributions from your income if you earn over a certain amount.
IF WE ARE ELIGIBLE, HOW MUCH CAN CONTRIBUTE?
- The lesser of $5,500 ($6,500 if you’re age 50 or older), or
- your taxable compensation for the year.
- As a general rule of thumb, try to invest at least 10 percent of your income for retirement.
WHAT IF YOU HAVE A FULL-TIME JOB THAT OFFERS A 401(k)?
You might still consider opening an IRA. If your employer offers a match, always contribute to that plan first. A 401(k) usually comes with a menu of options to choose from. With an IRA, you have to pick your own investments. This is great for flexibility, but it also means you’ll have to do a little more research.