What is an IRA and which one would suit you?
Once you get into the professional arena after a college education, you’re tucked with the responsibilities of making major financial decisions – insurance, debt payments, savings, investments, and of course, building a retirement fund.
However, the traditional and less troubling method of opting for a 401(k) isn’t always available for everyone – particularly to the freelancers and self-employed.
Thus, if you don’t have access to a 401(k), or you’re very keen to expand your retirement investments, the best-sought solution is an Individual Retirement Account (IRA).
What is an IRA?
According to IRS.gov, “IRAs allow you to make tax-deferred investments to provide financial security when you retire.”
Also known as Individual Retirement Arrangements, anyone can get access to an IRA if he or she is below 70½ years.
How many types of IRAs are out there?
There are multiple types of IRAs, but the most common is the Roth and traditional IRA. Just like a 401(k), an IRA also offers you a plethora of investment options to choose from, including stocks, bonds, and mutual funds.
You can save taxes on your income just by investing the additional funds in a traditional IRA. However, you’re taxed on the funds you withdraw after retirement. If you make $60,000 annually and put $7,000 in an IRA, you’ll be taxed on $53,000. However, you’re taxed on the money you put in a Roth IRA. However, you won’t be subject to any taxation when you withdraw the funds in retirement.
It should be noted here that if your spouse or you already have a retirement plan at work (like a 401k), you might not be eligible for a tax deduction with a traditional IRA.
Significantly, there are a few vital differences between the traditional and the Roth IRA. In Roth IRA if you are single, head of household, or married filing separately and you did not live with your spouse at any time during the year, and your adjusted gross income is under $116,000, you can contribute up to the limit. However, if your adjusted gross income is more than $116,000 but less than $131,000, you can contribute a reduced amount.
Nevertheless, if you are married and filing jointly, the maximum income threshold is $193,000. Couples with an adjusted gross income of $183,000 or less can contribute up to the limit; above that, the gradual reductions kick in.
People who have access to traditional IRAs must begin taking distributions by April 1 of the financial year after they turn 70½. On the contrary, Roth IRAs require no minimum distribution to the original owner.
How Much Can You Put in an IRA?
- $5,500 ($6,500 if you’re age 50 or older), or
- Your taxable compensation for the year, if your compensation was less than this dollar limit.
The IRA contribution limit does not apply to:
- Rollover contributions
- Qualified reservist repayments
IRA contributions after age 70½
You can’t make regular contributions to a traditional IRA in the year that you reach 70½ and older. However, you can still contribute to a Roth IRA and make rollover contributions to a Roth or traditional IRA regardless of your age.