10/13/2024
It’s Not Your Father's IRA Anymore
You have been saving for your retirement, but you may be feeling overwhelmed by the number of choices available to you. The options your individual retirement account offers you have significantly expanded since IRAs were originally created. This article is designed to give you an overview of individual retirement accounts, help you determine how an IRA fits into your retirement income, and your planning strategy since the Secure Act has become effective.
This article is not a complete discussion of all the benefits, and rules about IRAs. Consult your CPA, Attorney, and Investment Advisor about how an IRA applies to your circumstances.
What Is an IRA – and What Are Its Benefits?
An IRA is a long-term tax advantaged account that offers tax-deferred savings, and investments. It is a good option if you are self-employed, if your employer does not offer a 401(k), or other retirement plan, or as a supplement to your employer’s retirement plan. Depending on your income.
It differs from a 401(k), company or non-profit retirement plan. An IRA is an Individual Retirement Account, whereas a 401k, or company retirement plan, is an employer-sponsored retirement plan. You can open an IRA as long as you have earned income from an employer, self-employment, or any other source that is considered earned income. That means you can contribute to an IRA if you are employed, self-employed, you and your spouse earn income, you have been awarded a taxable scholarship, or fellowship, exercised non-qualified stock options, or even if you receive nontaxable combat pay. As long as the source of income is considered to be earned income, and you do not exceed the income thresholds.
The benefits offered by an IRA are dependent on the type of IRA you choose, the type of financial institution you open your IRA account with and the investments you choose for your IRA account. Opening an IRA account can be as simple as opening a savings account at your bank, as an IRA. To a self-directed brokerage account where you choose your own investments.
Advantages of an individual Retirement Account
1. Flexibility and Control (Self Directed IRAs): With a Self-Directed IRA, you can choose the savings, and investment vehicles which help you meet your retirement savings goals. These may include stocks, bonds, mutual funds and other investments.
With a self-directed IRA, you are not limited to a specific set of investments, as you may be with an employer-sponsored 401(k) or company retirement plan.
Self-Directed IRAs can be any type of IRA. Such as a Traditional IRA, or Roth IRA. Certain types of employer-sponsored retirement plans are comprised of Individual Retirement Accounts such as a SEP, (Simplified Employer Plan), and SIMPLE Plan, (Savings Incentive Match Plan for Employees). These plans can be used by people who are self-employed, or by companies who want to offer their employees a less complicated retirement plan.
Certain Banks, brokerage, and investment firms allow you to choose your own investments from the full universe of investments available. To meet your retirement savings goals in your IRA. These may include money markets, stocks, bonds, mutual funds and other investments. You are not limited to a specific set of investments.
Other providers of IRA accounts such as insurance companies, may limit your choice of investments to an insurance policy or an annuity. The key point to remember is, you are able to invest your contributions into any savings, or investment vehicle that is approved by the IRS to invest your IRA in.
Employer-sponsored 401(k) Plans, (and other types of retirement plans), offer a specific slate of investments from which you can choose, with some exceptions. IRA providers may offer IRA accounts for the purpose of investing solely in CD’s, savings accounts, life insurance policies, annuities, gold and precious metals, real estate and alternative investments. These financial institutions may limit IRAs to the savings, investment and insurance vehicles they offer.
2. Investment Performance: Over time, you may be able to achieve your goals by investing in vehicles that historically have outperformed savings, insurance, and other types of investments which can be placed in an IRA account. Always remember, investing carries a risk of loss, and past results are not a guarantee of future returns.
3. Tax Advantages: Individual Retirement Accounts offer the benefits of reducing your taxable income, with exceptions from tax consequences, and penalties, for specific types of hardships and withdrawals. Tax free income in the case of Roth IRA’s.
What Are the Most Common Types of IRAs?
Traditional IRAs, and Roth IRAs are the most common types of IRAs. Remember, fees associated with managing IRAs vary by provider.
Traditional IRA
Traditional IRAs typically offer you a greater tax advantage upfront because contributions may be tax deductible.
You and your spouse are able to contribute up to age 73. As long as your income falls below an annual amount set by the IRS. Enrollment in an employer-sponsored retirement plan may affect your eligibility.
You may need to determine if you should file your tax forms jointly with your spouse or individually. Consult your CPA, accountant or tax advisor.
You may withdraw money at any time, at any age. However, you may have to pay an additional 10% penalty plus income tax on the amount you withdraw. Hardship exemptions for the tax, and penalty may apply to you if you meet the requirements.
Tax deductions for your contributions depend on your income, and retirement plan coverage at your employer.
Traditional IRAs are tax deferred until money is withdrawn.
You, and your spouse are able to contribute up to age 73. As long as your income falls below an annual amount set by the IRS. Enrollment in an employer-sponsored retirement plan may affect your eligibility.
You may need to determine if you should file your tax forms jointly with your spouse or individually. Consult your CPA, accountant or tax advisor.
You may withdraw money at any time, at any age. However, you may have to pay an additional 10% penalty plus income tax on the amount you withdraw. Hardship exemptions for the tax, and penalty may apply to you if you meet the requirements.
Tax deductions for your contributions depend on your income, and retirement plan coverage at your employer.
Traditional IRAs are tax deferred until money is withdrawn.
Your Choice of financial institution determines investment choice, and if you can self-direct or not.
Contribution Limits:
2024:
- $7,000 Individual
- $8,000 If Over 50
2025: Yet to be released
You must start taking required minimum distributions when you turn 73.
Your total contributions to both your IRA, and your spouse's IRA may not exceed your joint earned income. Your marital status, living arrangements, and enrollment in an employer-sponsored retirement plan may affect your eligibility. Check with your CPA, Attorney, and Investment Advisor for information on how these circumstances may apply to you.
Roth IRA
If you choose a Roth IRA, you may enjoy more tax advantages in retirement since qualified withdrawals are tax-free.
With a Roth IRA:
You, and your spouse can contribute at any age, if your income falls below an annual amount set by the IRS.
Your contributions are not deductible from your taxable income.
You can withdraw contributions you make to your Roth IRA anytime, tax and penalty free, regardless of age. However, you may have to pay taxes, and penalties on earnings you withdraw from your Roth IRA. If they are non-qualified withdrawals.
A non-qualified withdrawal, or distribution, is determined by the 5-year holding period and the reason for your withdrawal.
Withdrawals at retirement age are tax free, provided your Roth IRA has aged at least 5 years.
You are never required to take distributions.
Contribution limits are the same as a Traditional IRA subject to income thresholds.
How Do I Open an IRA?
Ready to open an IRA? There are seven important steps you need to take.
1. Determine your retirement goals, and your income eligibility. These will guide the types of investments you choose.
2. Find a trusted IRA provider. While doing your research determine what investment options the provider offers. Assess fees, commissions, other charges and expenses associated with your account.
3. Fill out the required account application.
4. Designate your beneficiaries. Beneficiaries inherit assets in your IRA if you die. IRA accounts flow to your heirs by beneficiary designation. You can select primary beneficiaries, contingent beneficiaries and designate percentages. You want to consult your Attorney, CPA, and Investment Advisor about your beneficiary designations, if you are uncertain about the rules governing them. You may also want to consider tax, and legal advice about inherited IRA accounts, income, and other taxes your beneficiaries may become liable for.
5. Choose the right mix of investments. These are based on your specific goals. You may want to consult your Investment Advisor to help you select your investments.
6. Make your contributions. You may want to make your contributions annually, or periodically. Consult your CPA, and Investment Advisor to determine which is more advantageous for you. Behavioral economics research shows automatic contributions are an effective way to save regularly and consistently.
7. Monitor your account. If you have invested your IRA account in securities, or investments which fluctuate in value. Review your IRA account quarterly. Determine your time frame, and understand your tolerance for risk. Monitor your investment performance, assess market conditions and determine if you are meeting your financial goals.
What Are Your Investment Options?
With an IRA, you determine how your funds will be invested. Some investments are riskier, and understanding your personal level of risk tolerance is key to diversifying your investment choices.
Your investment options include, but are not limited to:
Money Markets: Money Markets are interest-bearing investments, comprised of short-term fixed income securities, with maturities of a year or less. Such as, Treasury Bills, Government Securities and Commercial Paper. These securities are considered to be cash equivalents, provide a stable return, while preserving capital and maintain high liquidity.
Bonds: Buying a bond means you are lending to the issuer, whether that is a corporation or a government. The issuer then pays you a specified interest rate. Be aware, bonds fluctuate in value relative to changes in interest rates, market and economic conditions.
Stocks: With these investments, you buy shares of ownership in a company.
Mutual Funds: A mutual fund is an investment company that pools money from many investors, and invests that money into a collection of securities. Each mutual fund has an investment objective, and prospectus, which describe the investments in the Mutual Fund and how the fund operates.
Index Funds: Similar to mutual funds, index funds maintain an investment portfolio that closely follows a particular market index, such as the S&P 500.
Exchange-Traded Funds (ETFs): ETFs are similar to mutual funds. They trade on an exchange like individual stocks.
Real Estate Investment Trusts (REITs). These are companies that own, or finance income-producing real estate.
Fixed and Variable Annuities: These are contracts between you, and an insurance company, which offer consistent income generated from interest or investments.
A Note of Caution: In these uncertain times, you may want to determine the level of account insurance your IRA provider offers. All IRA providers are required to offer FDIC, (Federal Deposit Insurance Corporation) and SIPC, (Securities Investor Protection Corporation) insurance, which protects cash up to $250,000 and securities up to $500,000. These forms of insurance protect against a default of the financial institution you choose to hold your IRA with. They do not protect against market fluctuation.
Some financial institutions offer account insurance over and above the limits of FDIC and SIPC. Purchased privately for the benefit of account holders. Making this determination requires asking if the financial institution offers it, and at what levels.
In conclusion: Individual Retirement Accounts offer tax advantages such as, income reduction, tax deferral, and tax-free income at retirement, in the case of Roth IRA accounts. IRA accounts provide the flexibility, and control to direct your contributions into savings and investment vehicles of your choice. Depending on your selection of IRA custodian, (the financial institution you open your IRA account with).
IRA accounts offer you the flexibility to make contributions directly, periodically, and roll over funds from a company retirement plan, such as a 401(k). IRA accounts can help you meet your goals to create retirement income, have funds to access in the event of a hardship, purchase a home as a first-time home buyer and make charitable contributions if you choose.
When considering a rollover from your company retirement plan. Always consider the expenses of participating in your company retirement plan, versus the expenses you will incur in an IRA. You may also want to consider the degree of protection your retirement savings enjoy from liability, in employer-sponsored retirement plans. Such as, a 401(k) plan. Consult your attorney for more information.
Managing IRA accounts can get complex. If you need help your Attorney, CPA and your Investment Advisor are the people to talk to.
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If you have further questions, or concerns call The Investment Advisor at: 570-815-0770
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