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Understanding Individual Retirement Accounts (IRA’s)

by Nehemiah Marcus

Individual retirement accounts (IRAs) are a straightforward, tax-advantaged way to save for retirement. There are numerous IRA account options and strategies to consider. Our guide will give you an in-depth look at all of them.

Disclosure: This article was paraphrased from annother article on Forbes and repurposed for educational use. It’s designed to encourage people to seek professional financial advice through our short Finance Quiz. You can access the original article link at the bottom of this page.

IRA’s Explained

An IRA is a retirement savings account that offers tax-free investment growth as well as a variety of other tax benefits. Anyone who earns money, and even some who don’t, can contribute to an IRA.

By allowing your money to grow tax-free, IRAs are invaluable tools for planning a financially secure retirement. This special treatment provides compound growth above and beyond that of a taxable investment account.

Consider this scenario: If you invested $5,000 per year in an IRA with a 7% average annual return for 40 years, you’d have just over $1 million by the time you retire.

Given the impact of income and capital gains taxes from the trades required to manage your portfolio over four decades, if you made the same investment in a taxable brokerage account, you’d have just under half that amount. That’s why putting money aside in a tax-advantaged account can help boost your retirement savings.

IRAs offer additional tax advantages depending on whether you save in a traditional or Roth IRA.

Comparing Traditional IRA’s and Roth IRA’s

For 2022, annual IRA contributions are limited to $6,000, or $7,000 if you are 50 or older. Annual IRA contributions will be limited to $6,500 in 2023, or $7,500 if you are 50 or older.

In an IRA, you cannot save more than your taxable income. Additional contribution rules apply to both traditional and Roth IRAs.

Contribution Limits for Traditional IRA’s

If you choose a traditional IRA, your income and whether you (or your spouse) have an employment retirement plan will determine how much of your annual contributions you may write off against taxes.

Tax Deduction Income Limits for Traditional IRA’s in 2022 and 2023

If you’re filing as a single head of household or qualifying widow or widower and you make less than $68,000 in 2022 or less than $73,000 in 2023 then you can make a full deduction up to your contribution limit. If you make $68,000 to $78,000 in 2022 or $73,000 to $83,000 in 2023 then you can make a partial deduction and if you make more than $78,000 in 2022 or more than $83,000 in 2023 then you get no deduction. If you are married filing jointly or qualifying widow or widower and you make less than $109,000 in 2022 or less than $116,000 in 2023 then you get a full deduction up to your contribution limit. If your joint income is between $109,000 and $129,000 in 2022 or between 116,000 and $136,000 in 2023 then you get a partial deduction and if your combined income is more than $129,000 in 2022 or more than $136,000 in 2023 then you get no deduction. If you’re married filing separately and your income is less than $10,000 in 2022 or 2023 then you get a partial deduction and if your income is more than $10,000 in either year then you get no deduction.

You can technically contribute to a traditional IRA with non-deductible contributions. Simply put, you won’t get a tax advantage right away and will be required to pay taxes when you remove any gains. You can also convert them through a backdoor IRA, which we discuss later.

Contribution Limits for Roth IRA’s

Whether or not you have access to a corporate retirement plan, the amount you may contribute to a Roth IRA depends on your yearly income.

Income Limits for Roth IRA’s in 2022 and 2023

If you’re filing as a single head of household, married filing separately but never lived together during the year and you make less than $129,000 in 2022 or less than $138,000 in 2023 then you can contribute up to the annual limit. If you make $129,000 to $144,000 in 2022 or $138,000 to $153,000 in 2023 then you may contribute a reduced amount and if you make more than $144,000 in 2022 or more than $153,000 in 2023 then you can contribute zero. If you are married filing jointly or qualifying widow or widower and you make less than $204,000 in 2022 or less than $218,000 in 2023 then you can contribute up to the annual limit. If your joint income is between $204,000 and $214,000 in 2022 or between $218,000 and $228,000 in 2023 then you may contribute a reduced amount and if your combined income is more than $214,000 in 2022 or more than $228,000 in 2023 then you may contribute zero. If you’re married filing separately and your income is less than $10,000 in 2022 or 2023 then you may contribute a reduced amount and if your income is more than $10,000 in either year then you may contribute zero.

You won’t be able to contribute directly to a Roth IRA if your income is higher than those we just previously described, but you might be able to contribute to a Roth 401(k) or do a backdoor Roth conversion, which is detailed later

Withdrawing your IRA

The day comes when you begin to withdraw funds from your IRA account after decades of accumulating your balance.

You can withdraw money penalty-free from any kind of retirement plan if you’re 59 12 years of age or older. Depending on your current income tax bracket, you’ll have to pay taxes on any money you withdraw from a traditional IRA.

Tax-free withdrawals from a Roth IRA are possible, but there are certain restrictions. You might owe taxes on withdrawals of earnings if it has been less than five years since you first financed a Roth account (and you might also be subject to a penalty).

Another thing to keep in mind is that once you turn 72, you must begin taking required minimum distributions, which are percentage withdrawals from your conventional IRA (RMDs). RMDs are not yet applied to Roth IRAs.

Early Withdraw of IRA’s

A 10% early withdrawal penalty and income taxes on the amount are due if you need to take money out of a traditional IRA before the age of 59 12.

You can avoid the early withdrawal penalty (but not the taxes) if you meet a few early withdrawal exceptions:

• Purchase of a first home (withdrawal of up to $10,000)
• A child’s birth or adoption (withdrawal of up to $5,000)
• Qualified costs of higher education
• Licensed medical costs
• The cost of health insurance when you’re unemployed
• Periodic payments that are substantially equal under Rule 72 (t)
• After your passing, a beneficiary withdraws the money.

If you only remove contributions that you have made to your account, you can also avoid paying taxes or penalties if you make an early withdrawal from a Roth IRA. (Remember that you previously paid taxes on these?)

In any case, once the money is in the account, the usual rule of thumb with regard to IRA savings is that you shouldn’t touch it until you’ve reached the legally required retirement age.

Why Opt for an IRA

Opening and funding an IRA may seem like a no-brainer given the significant tax benefits they provide. If you’re still unsure, consider opening an IRA for the following reasons:

• You do not participate in a 401(k) or other workplace retirement plan. An IRA is one of your finest options for saving money if your employer doesn’t offer one.

• You participate in your company’s retirement plan, but you don’t like the investing choices. If the 401(k) fund choices offered by your employer are few or have higher fees than you’d like, starting an IRA can provide you with more affordable, superior funds. Just make sure you’re making enough contributions to your 401(k) to qualify for any matching contributions. If you’re making conventional IRA contributions, keep in mind that the amount of tax deductions available to you may be restricted based on your income.

• You do not participate in a 401(k) or other workplace retirement plan. An IRA is one of your finest options for saving money if your employer doesn’t offer one.

• You participate in your company’s retirement plan, but you don’t like the investing choices. If the 401(k) fund choices offered by your employer are few or have higher fees than you’d like, starting an IRA can provide you with more affordable, superior funds. Just make sure you’re making enough contributions to your 401(k) to qualify for any matching contributions. If you’re making conventional IRA contributions, keep in mind that the amount of tax deductions available to you may be restricted based on your income

What Kinds of IRAs Are There?

Almost any type of retirement saver may find a specialized IRA, from business owners and non-working spouses to gold speculators and Bitcoin fanatics.

Spousal IRA

According to IRS regulations, a non-earning spouse may contribute to their own individual retirement account as long as they file a joint tax return with their spouse who does receive an income. This situation is known as a “spousal IRA.” IRAs for a spouse can be Roth IRAs or standard IRAs.

In 2022, couples are allowed to make contributions up to the lesser of their combined yearly taxable income or $12,000, $13,000 if one partner is 50 or older, or $14,000 if both are. These caps will increase to $13,000 in 2023 if both spouses are younger than 50, $14,000 in 2023 if one spouse is older than 50, and $15,000 in 2023 if both are older than 50.

Inherited IRA

An inherited IRA, often referred to as a beneficiary IRA, is an account that contains funds inherited from a decedent’s IRA or another defined contribution retirement plan, such as a 401(k) (k).

Any individual or entity may receive an IRA as an inheritance from a decedent, though spouses typically have the greatest management options for their inherited IRAs.

SEP IRA

Small business owners and the self-employed can use a Simplified Employee Pension, also known as a SEP IRA. Any business may implement a SEP IRA plan, but normally only the employer (and not the employees) makes contributions. This disparity doesn’t matter to self-employed people.

SEP IRA contribution limits are significantly higher than those of regular IRAs. In 2022, employers are permitted to contribute up to $61,000, or 25% of an employee’s salary, whichever is less; in 2023, the cap increases to $66,000, or 25% of an employee’s income. Self-employed people or companies who fund their own SEP IRAs may make a little less of a contribution.

SIMPLE IRA

A SIMPLE IRA is a retirement plan for companies with less than 100 employees. It stands for Savings Incentive Match Plan for Employees. Unlike the SEP IRA, this type of IRA allows contributions from both employers and employees.

While employers are required to make contributions to a SIMPLE IRA, employees are free to decide whether or not to do so. For 2022 and 2023, the maximum employee contributions are $14,000 and $15,500, respectively.

Employers have the option of making 2% of employees’ salaries in contributions or 3% of employees’ salaries in dollar-for-dollar matching contributions.

Self-Directed IRA

You are often only able to invest in stocks, bonds, certificates of deposit (CDs), and funds, such as mutual funds or exchange-traded funds, with most IRAs (ETFs). You can own and trade a range of alternative investments with a self-directed IRA, including precious metals, real estate, and even cryptocurrencies.

Although investing in these non-traditional retirement investments may seem enticing, self-directed IRA custodians have less obligations to look into the assets or the history of the promoter of those assets, leaving them more vulnerable to deception.

Gold IRA

A particular kind of self-directed IRA called a gold IRA enables you to invest retirement money in actual gold. Normal IRAs are unable to store tangible valuables like gold.

When you possess actual gold in a tax-advantaged account, you need to manage the additional paperwork, tax reporting, and insurance that is necessary. Gold IRA businesses can help you with this. You can purchase gold-related equities or gold ETFs in a standard IRA if you wish to increase your retirement savings without incurring any additional costs or hassles.

Bitcoin IRA

Another self-directed IRA option that enables cryptocurrency investments for retirement is the Bitcoin IRA. Similar to gold IRAs, providers of Bitcoin IRAs assist you in handling the challenging additional work of maintaining cryptocurrency assets in a tax-advantaged account.

Despite the fact that you cannot hold cryptocurrencies in conventional IRAs, you can use a traditional brokerage to invest in funds and businesses that do.

Rollover IRAs

Simply put, a rollover IRA is an ordinary IRA that contains money you’ve transferred from an employer-sponsored retirement plan, such as a 401(k) (k). Moving your retirement funds from an existing 401(k) to a new IRA may make sense if you’re switching jobs, transitioning to self-employment, or are close to retirement.

If your prior employer’s 401(k) offers few investment alternatives or isn’t open to departing employees, you should consider rolling over your IRA. As an alternative, you might want to transfer money into a Roth IRA to benefit from tax-free retirement withdrawals or to avoid RMDs. However, bear in mind that you might have to pay taxes on the amount you convert if your account is not already a Roth account.

Backdoor Roth IRA

An investment approach known as a “backdoor Roth IRA” uses an IRS tax loophole to give high-income people access to Roth IRAs. This technique involves starting a traditional IRA, financing the account, then immediately performing a Roth conversion in order to streamline a relatively complex process.

How to Open an IRA

A new IRA can be opened with ease. An online brokerage is your best pick if you’re a hands-on investor who enjoys researching markets and trading stocks. Uncertain about where to begin? To assist you in selecting a platform, look through our ranking of the top online brokers.

Investors who prefer to stay out of the way can consider using a robo-advisor or working with a financial professional. If you fall somewhere in the middle, think about creating a portfolio of two or three index funds or ETFs.

There are several ways to start an IRA. Alternative IRAs, like the ones mentioned above, are provided by specialized self-directed IRA providers. Additionally, the majority of the big banks provide IRAs, however they frequently can only hold CDs and other deposit items.

Source Disclosure: This article was paraphrased from an article on Forbes and repurposed for educational use only. It is designed to encourage people to seek professional financial advice through our short Finance Quiz. Click below to access the original article.

https://www.forbes.com/advisor/retirement/ira-individual-retirement-account/

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