An IRA, or an individual retirement account, is an easy and accessible way to save for retirement, particularly if you don’t have a 401(k) retirement plan through your employer. As long as you have earned income, you can open an IRA.
IRAs are appealing for a few key reasons: They offer tax advantages, can be low-maintenance, and take just minutes to open.
There are several different kinds of IRAs, but the most common are the traditional IRA and the Roth IRA.
A traditional IRA is tax-deferred, meaning you can make pre-tax contributions, and you won’t pay taxes on that money until you start making withdrawals in retirement. If you make withdrawals before age 59½, you’ll typically be hit with taxes and a 10% penalty—although there are a few exceptions, like if you take out funds to buy your first home or cover college tuition.
There are also other good reasons not to raid your IRA before you retire, though: You’re taking away from your future self, and you’re limiting the potential of compound interest.
Roth IRAs are funded with after-tax dollars, and they also offer tax-free growth. What’s different is they offer tax-free distributions in retirement, says Melissa Ridolfi, vice president of retirement and college leadership at Fidelity Investments.
Roth IRAs also give you more flexibility to access your money before you retire: You can take out what you’ve contributed at any time without taxes and penalties. Withdrawing what you’ve earned before retirement, however, can still be subject to taxes and penalties if you don’t qualify for an exception.
“A contribution is the money I put in,” Ridolfi explains. “If I invest those dollars in a mutual fund and get earnings on my investments, let’s say 6%, that’s my earnings portion.”
How much can you contribute?
For Roth and traditional IRAs, you can contribute a maximum of $6,000 for 2019, or $7,000 if you’re 50 or over and making a catch-up contribution.
If you have a retirement plan though your employer, experts usually recommend putting in enough to get the full company match in your 401(k) before you focus on your IRA. But if an IRA is your primary investment vehicle, it’s ideal to max it out each year, and if you can’t, you should contribute as much as you can, says Ridolfi.
“Whatever you can afford, save and save regularly,” says Ridolfi. “Get as close to that $6,000 limit as you can. Think of it like a bill you’re paying to yourself each month.”
The IRS also sets income limits that affect how much you can contribute (Roth IRA) and how much of your contributions are deductible (traditional IRA). Pay attention to those as your salary increases. For example, in 2019, your eligibility to make Roth IRA contributions starts phasing out when you have taxable income of $122,000 as a single taxpayer, and at $193,000 for those married filing jointly.
When should you consider an IRA?
Experts say you should save 10%-15% of your income each year if you want to retire comfortably by age 65. The earlier you start contributing to your retirement, the better. Even if you have access to a 401(k) or another retirement plan through work, opening your own traditional or Roth IRA can give you additional flexibility.
You might be able to open an IRA well before you’re eligible for workplace retirement plans, too. About 4 in 10 companies impose a wait of three months or more before you can start contributing to your 401(k), according to data from the Plan Sponsor Council of America. And roughly a third of private sector employees work for a company that doesn’t offer a retirement plan like a 401(k), according to Pew Charitable Trusts.
Get as close to that $6,000 limit as you can. Think of it like a bill you’re paying to yourself each month.
If you don’t have a 9-5 and instead earn your money with contract work, freelancing, and side hustles, saving for retirement via an IRA may be an especially appealing option.
In short, you can open up an IRA any time, on any career path. And the sooner you do it, the more time you give your wealth to grow.
You’ve set up an IRA. Now what?
Once you open an IRA, generally through a brokerage or a bank, the next step is to pick investments. Another benefit of an IRA, as opposed to a 401(k), is that you often have more of a say in how your money is invested.
Put some time into determining the asset allocation and the type of fund (index, mutual, exchange-traded) that works best for you, depending on your target retirement date, tolerance for risk, and your financial goals, so that you can make the most of your IRA—and your retirement.
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