When planning for retirement, many Americans choose one or more types of individual retirement accounts (IRAs) to minimize taxes while maximizing their savings. An IRA is essentially a long-term savings account that can be used to earn on and invest funds, and is a great alternative for people without access to an employer-provided retirement account, such as a 401(k).
If you’re considering an IRA or are refreshing yourself on the do’s and don’ts, we’ve got you covered with this basic guide in which we’ll cover top things to know and a few things you might not have known about IRAs.
All information provided is strictly educational. SouthEast Bank recommends consulting a legal, financial, and/or tax advisor before entering into any financial transaction.
What You Need to Know About IRAs
Who can open an IRA? Anyone who earns income of any kind—salary, tips, or hourly wages—can contribute to a traditional IRA. This includes minors as well as people who already hold or intend to enter an employer-provided 401(k) account. It’s never too early to begin saving for retirement, and there’s no one way to do it!
How do you open an IRA? You have a couple of options, from depository institutions such as credit unions or banks, to a personal broker, an investment company, or an online brokerage.* Essentially, any of these can assist you with opening and maintaining your IRA, so your choice can be based on to needs, circumstances, and comfort level.
*With the rise of financial scams, be vigilant about where and when you provide your personal and financial information, particularly online brokerages.
How can I invest with my IRA? After opening an IRA, you can choose from a number of investment options to earn more with your funds, including stocks, bonds, exchange-traded funds (ETFs), mutual funds, and, in certain cases, real estate. Depending on the size of your IRA, you may choose to elect a professional manager to invest your funds on your behalf.
What types of IRAs are there? There are advantages and drawbacks to the various IRA options you have, including:
- Traditional IRA – In a Traditional IRA, investments in the account are tax-deferred, but withdrawals in retirement are taxed like any other form of income.
- Roth IRA – Contributions to a Roth IRA are made after tax so are not deductible. However, earnings, including investment gains, are tax-free. There is a greater access to your Roth IRA funds without penalty, versus a Traditional IRA.
- Simplified Employee Pension (SEP) IRAs – In a SEP IRA, the sole contributions are made by the employer directly to an employee’s IRA, including self-employment. This is a useful benefit for a variety of business types.
- Savings Incentive Match Plan for Employees (SIMPLE) IRAs – This plan allows for employers and employees to both contribute to an IRA, often on a limited match scale.
- Self-Directed IRA (SDIRA) – In this type of IRA, account owners can directly invest their funds, for instance in stocks, commodities, or real estate.
What are the limitations of IRAs? Because the purpose of IRAs is to set aside funds for retirement, there are penalties (typically 10%) for withdrawing funds before reaching a certain age (59½). While there are exceptions to this guideline, such as withdrawing to cover education expenses or first-time home purchases, it’s recommended that these funds remain deposited in your IRA to maximize long-term growth.
On the other hand, account owners are required to begin withdrawing from their IRA at the age of 73 in what are called required minimum distributions (RMDs). RMDs are treated as a form of income, so are taxable and can impact tax bracket placement.
IRA contributions must be in cash, and the total amount you can contribute in a single year is limited
Additional Tips for Maximizing Your IRA
Now that we’ve covered some of the basics, let’s address a few common questions about how to utilize your IRA. Review the following tips and remember to consult a trusted professional about your goals and options!
Save Yourself Time & Money
IRA contributions, like any long-term savings, take time to compound. So it’s advisable to kickstart your IRA early—not only in the span of your professional earnings but also within each tax year. As one Morningstar contributor helpfully puts it, “Investors have until their tax-filing deadline—usually April 15—to make an IRA contribution if they want it to count for the year prior.”
So, it’s easy to put it off, “squeaking in their contributions right before the deadline rather than investing when they’re first eligible (Jan. 1 of the year before). Those last-minute IRA contributions have less time to compound—even if it’s only 15 months at a time—and that can add up to some serious money over time.”
To avoid remembering these annual timeframes, automate your contributions! Even if you don’t have your full amount ready, you can set smaller installments that will add up over the tax year.
Match When You Contribute to Where You Contribute
There are many misconceptions about what IRAs can and can’t do for you, depending on your age. Young professionals might put off establishing an IRA, for instance, given that they might want greater access to their funds that might be “tied up” in a retirement account. Older professionals might choose not to use an IRA because it will not have time to mature by the time they would want to use it.
However, Roth IRAs might be a good solution in both of these instances. Roth IRA contributions and earnings can be withdrawn under certain circumstances without taxes or penalties, which may put a younger investor at ease. Similarly, an older contributor might utilize a Roth IRA to set aside funds not for themselves but for their children or other beneficiaries, who can inherit the account and take tax-free withdrawals, all while avoiding RMDs.
Investigate your IRA options. You may find that there is a better fit than you anticipated!
Keep Your Beneficiaries in Mind
You may be able to contribute to an IRA on behalf of your spouse, even if they themselves are not employed. Doing so can raise the threshold for contributions from one to two individuals per calendar year and is often a great choice to combine savings rather than hold a separate account that is earning at a lower rate.
When planning for retirement or end-of-life, IRA account holders might be unaware that their beneficiary designations supersede estate plans. It’s important not to “set it and forget it” with this part of your account. Install reminders for yourself to keep your designations up to date, and at a minimum review your account setup each time you make adjustments to your will or other legal plans, especially as legal regulations change from time to time.
Leaving an IRA behind to your loved ones is a fantastic legacy, but depending on how they are related to you this inheritance may cause more headaches than joy. Be sure to consult your advisor before matching the account to the beneficiary.
Final Considerations
As with any investment or savings strategy, there are drawbacks and risks that you assume when you enroll. Earnings fluctuate, brokerages merge or disband, and the market goes through year-long and decades-long dips. Always perform your due diligence before making a financial transaction and regularly review your risk tolerance with your funds.
As we make our way through tax season, consider what goals you might have for your IRA account(s) this time next year. Every year counts when contributing to your retirement or setting aside funds for your family, and IRAs offer a number of resources to the savvy saver. Don’t hesitate to speak to a professional about your questions, concerns, and interests, and set up an account—or more than one—today!
Reminder: All information provided is strictly educational. SouthEast Bank recommends consulting a legal, financial, and/or tax advisor before entering into any financial transaction.
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