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Making Good Sense of IRAs

|| Staff Blog: Cathy Cagle ||

Saving for retirement isn’t optional, though it can feel that way. You are the only one who can make the decision to invest some of your hard earned precious income instead of spending it. Finding the bandwidth in your budget to set aside funds can be a struggle! The good news is that the immediate pain of dedicating part of your income to future needs may be offset by a reduction in the amount of tax you’ll pay provided you put your money in an Individualized Retirement Account or IRA. 

IRAs were created in 1974 and have been called ‘the biggest tax break in history’. Tax breaks translate into more money in your pocket – in this case, more money in your pocket today and in your future retirement pocket. 

What exactly is an IRA? An IRA is an account set up at a financial institution that allows you to save for retirement with tax benefits. Depending on the type of IRA, the money in your account can grow tax-deferred or tax-free. An IRA is not itself an investment but an account from which you can invest the funds contained in it.

Some basics that apply to every kind of IRA:

  • You must have earned income to be able to contribute to any kind of IRA. Qualifying earned income includes wages, salaries, tips, bonuses or net income from self employment. Interest, dividend and or rental income does not qualify.
  • There is no ceiling on how much income you earn to be eligible to contribute to an IRA.
  • The maximum contribution to a Roth or Traditional IRA for tax year 2019 is $6,000 if you are 59 or younger, $7,000 if 60 or older.
  • You and your spouse can each make IRA contributions and you may be able to contribute to your spouse’s IRA and deduct the contribution, if contributed to a Traditional IRA, if you meet certain requirements known as the Kay Bailey Hutchinson Spousal IRA limit.
  • If you have more than one Traditional IRA, the annual limit on contributions applies to any contributions made to all of your combined Traditional IRAs..
  • If you contribute to both a Traditional IRA and a Roth IRA, your limit is the maximum allowed for you under a Roth minus anything contributed to your Traditional IRA.
  • The deadline for making IRA contributions is tax day of the year following the year in which you claim them (you can make contributions after a year ends, to a point.). 
  • There is no age limit for how old you can be to make an IRA contribution.
  • If you make contributions to a retirement plan through your employer, your ability to contribute to an IRA could be limited by your adjusted gross income. 
  • You must start receiving distributions from your IRA by April 1st following the year in which you turn 72.
  • Households with adjusted gross incomes below $64,000 or individuals with adjusted gross incomes below $32,000 may qualify for a Savers Credit of $1,000 to $2,000 for making IRA or 401(k) contributions.
  • Learn more from this IRS publication.

There are two main types of IRAs, Traditional and Roth. 

Traditional IRA: Contributions to a traditional IRA are tax-deductible, to a certain amount, lowering the taxable income you report for that year. Contribution caps sometimes change annually and are different for those closer to retirement, age 50 and up. Your IRA grows tax-deferred, meaning you don’t pay tax on your Traditional IRA until you withdraw from it in retirement, at which time you would be taxed on what you withdraw each year. Because most people have a lower income level in retirement, you may pay less in taxes than you would have if you were taxed at the time of investment. 

Traditional IRAs include individual retirement accounts, individual annuity accounts, individual retirement bonds, SIMPLE IRAs, Simplified Employee Pensions (SEPS), and Employer and Employee Association Trust Accounts.

Roth IRA:  Roth IRAs are funded by money on which you’ve already paid income taxes. Because the funds have already been taxed, your Roth compounds without being taxed and therefore withdrawals in retirement are not taxed. Some financial experts envision much higher tax rates in the not so distant future and see paying taxes now, at lower rates, as the best financial strategy. There are adjusted gross income ceiling limits on who can open or contribute to a Roth IRA. Contributions to a Roth IRA are not reported on tax returns.

Roth IRAs include individual retirement accounts and individual annuity accounts. Neither SEP IRAs nor SIMPLE IRAs can be designated as Roth IRAs.

Most of us will transition several times between different employers over the course of our employment life time. If you participated in an employer sponsored retirement plan, like a 401(k) or 403(b) plan, you have the option of rolling over your retirement account balance into either a Roth or a Traditional IRA upon terminating employment with that employer. If you choose to roll over your account into a Roth, you pay taxes on the entire account as taxable income at the time of conversion. Rolling over into a Traditional IRA defers income tax until you withdraw funds in retirement.

We all get older, every day – and that retirement that seems so far off in the future draws nearer. Getting older is inevitable but having adequate funds for our older years requires diligence and discipline to build those funds. One of the best tools for funding your golden years are IRAs. Understand the unique advantages offered by Roth and Traditional IRAs and use them to your maximum advantage. 

_______________________________________________________________________________

Cathy Cagle is a freelance writer and marketing consultant who has been working together with Jordan Goodman since 2015. 

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