IRA
It is estimated that an individual will need [latex]80 - 85\%[/latex] of their pre-retirement income when entering retirement. Employer sponsored retirement plans may not be enough to reach this savings goal. There are other forms of savings and investing an individual can do to prepare for retirement. One of those is an individual retirement account (IRA).
An IRA is a type of savings account that is designed to help you save for retirement with tax-free growth or on a tax-deferred basis. The specifics depend on the type of IRA you have.
individual retirement account (IRA)
An IRA is a long-term savings plan that provides tax advantages for retirement savings.
There are two main types of IRAs – Traditional and Roth.
traditional vs Roth IRAs
Traditional IRA
In a traditional IRA, contributions are often tax-deductible, depending on your income, filing status, and whether you or your spouse have a retirement plan at work. All earnings and contributions are tax-deferred, which means you don’t pay income tax until you make withdrawals, typically in retirement. The penalty for early withdrawal (before age [latex]59 \frac{1}{2}[/latex]) is typically [latex]10\%[/latex], in addition to being taxed at your normal income tax rate.
Roth IRA
Roth IRA contributions are made with post-tax income, meaning you pay taxes now rather than in retirement. One advantage of a Roth IRA is that you can withdraw your contributions (but not any earnings on those contributions) at any time, tax-free and penalty-free. Once you are [latex]59 \frac{1}{2}[/latex] and have held the Roth IRA for at least [latex]5[/latex] years, you can withdraw both contributions and earnings with no tax or penalty.
Both traditional and Roth IRAs have a contribution limit. As of 2023, the contribution limit for both traditional and Roth IRAs is [latex]$6,000[/latex] per year (or [latex]$7,000[/latex] if you are age [latex]50[/latex] or older). Roth IRAs have an income limitation that can limit your ability to contribute based on your filing status and income.
IRAs offer significant tax advantages. The type of IRA you choose can affect your taxes either at the contribution stage or during retirement withdrawals. Consider your current tax situation and expected tax situation in retirement. If you anticipate being in a higher tax bracket in retirement, a Roth IRA could be beneficial. Conversely, if you expect to be in a lower tax bracket in retirement, a traditional IRA might be a better fit. It’s essential to consult with a financial advisor or tax professional when choosing an IRA to ensure it aligns with your retirement goals and tax situation.
Opening an IRA is an easy process that can be done at most banks, credit unions, online brokers, and other financial service providers.