Attorney John Mlnarik
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Saving for Retirement
What is an IRA?
An individual retirement account, or IRA, is a type of plan provided by many financial institutions that provides tax advantages for retirement savings in the United States. An individual retirement account is a type of individual retirement arrangement as described in IRS Publication 590, individual retirement arrangements (IRAs). On the simplest level, an IRA is a savings account with big tax breaks, making it an ideal way to save for retirement. A lot of people mistakenly think an IRA itself is an investment. On the contrary, it is simply a basket in which individuals keep stocks, bonds, mutual funds and other assets. Unlike a 401(k), which is provided by an employer, certain IRAs can be created voluntarily by individuals in the workforce.
There are many different kinds of IRAs, and each has eligibility restrictions based on income or employment status. And all have caps on how much individuals can contribute each year and penalties for withdrawing funds before the designated retirement age.
Different IRAs: Roth and Traditional
There are four main types of IRAs, but the ones we will focus on for this article are Roth and Traditional IRAs. These are the two types that can be opened by individuals independently from employer-provided retirement plans.
The age limit for contributing to a Traditional IRA is 70 years and six months. If a person qualifies, his or her contributions to traditional IRAs can be tax deductible. For example, if someone contributes $5,000 to his or her IRA, he or she can claim that amount as a deduction on an income tax return, and the IRS does not apply income tax to those earnings.
An individual qualifies for a full tax deduction for IRA contribution if his or her spouse is not covered by a retirement plan at work. However, if an individual or his or her spouse is covered by a retirement plan at work, the individual’s deduction may be limited if his or her income exceeds certain levels. If the individual is married filing jointly and the spouses are covered by a retirement plan, they receive no deduction if their adjusted gross income is $196,000 or more, a partial deduction if their adjusted gross income is between $186,000 and $196,000, and a full deduction if their adjusted gross income is less than $186,000. If an individual is married filing separately and his or her spouse is covered by a retirement plan at work, he or she may take a partial deduction if his or her adjusted gross income is less than $10,000, but no deduction if his or her adjusted gross income is more than $10,000.
With these deduction limits in mind, it is also important to note that there are limits to how much an individual can contribute to his or her IRA on an annual basis. The total yearly amount is the smaller of: a) $5,500 if he or she is younger than 50, or $6,500 if he or she is older than 50, or b) his or her taxable compensation for the year. The deadline to make these contributions is the tax return filing deadline, not including extensions.
An individual may begin withdrawing funds from a Traditional IRA account at any time. However, the individual must start taking distributions by April 1 following the year in which he or she turns age 70 years and six months. After that, he or she must make distributions by December 31 after that initial April 1 deadline.
Any deductible contributions and earnings an individual withdraws or that are distributed from his or her Traditional IRA are taxable. Also, if the individual is under age 59 years and six months, he or she may have to pay an additional 10% tax for early withdrawals unless he or she qualifies for an exception.
Unlike traditional IRAs, there is no age limit for contributing to a Roth IRA, meaning contributions can be made at any time. However, the individual must have taxable compensation and his or her modified adjusted gross income must be below certain amounts. Contributions to a Roth IRA are not deductible.
As with Traditional IRAs, yearly contributions to Roth IRAs are the smaller of: a) $5,500 if an individual is younger than 50, or $6,500 if he or she is older than 50, or b) his or her taxable compensation for the year. The deadline to make these contributions is the tax return filing deadline, not including extensions.
If a distribution or withdrawal is qualified, then it is not taxed. Otherwise, part of the distribution or withdrawal may be taxable.
A distribution or withdrawal is qualified if: a) it is made five years after the individual set up a Roth IRA for his or her benefit, and b) the payment or distribution is made after the individual reaches the age of 59 years and six months, or the distribution is made because the individual is disabled, or the distribution is made to a beneficiary or to an individual’s estate after the Roth IRA holder’s death, or if the payment or distribution meets the requirements listed under First home under Exceptions in the IRS code.
Factors to Consider When Opening an IRA
When making the decision on whether to open a Traditional or Roth IRA, try to estimate whether you will be earning income past the age of 70. That is one of the primary factors that will determine whether you will be able to make contributions to the IRA if you are still working at that age.
In addition, research administrative and maintenance costs associated with IRA account providers, such as account fees, transaction fees, and the level of customer support provided for the account. These services and charges can vary from provider to provider, so choosing the right one can be important. If the holder of an IRA account plans on trading stocks with funds from the account, it is important to check whether the account provider will charge commissions for exchanges or any profits.
One of the most significant factors is how you choose to fund your IRA. For some, monthly contributions are an easy way to manage finances, while others will wait until the end of the tax season to determine how they should allocate their funds after they determine their yearly expenses. If an individual chooses monthly contributions, he or she should check with the account provider to see if it can provide automatic transfers of a set amount of money to the IRA every month.
If you pay attention to these factors before and after opening an IRA, then you should be well prepared for retirement. Though taking these extra steps can be time intensive, such diligence pays off in the long term. If you need help preparing an IRA, call an attorney or CPA to formulate and implement a plan that works best for you.