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You’ve probably heard from a young age that it’s never too early to save for retirement. And maybe he’s now earned enough money to comfortably put some away. Congratulations! But where do you start?
One option is an individual retirement account or IRA. If you’re looking for a way to save for retirement and don’t have a 401(k), an IRA may be the best option for you.
There’s a lot to know about IRAs before you even think about getting started. How much can you put in an IRA? What happens when you take money from him? Where does that money go? And what type do you qualify for?
Let’s start with the basics.
What is an IRA account?
An individual retirement account (IRA) is an account set up for the express purpose of saving money for retirement. A tax-deferred savings account, the IRA has been around since 1974, when Congress passed the Employee Retirement Income Security Act (ERISA) with the intent of encouraging people to save for retirement.
If you don’t have a 401(k) or aren’t offered one at work, setting up an IRA might be the next best option. You’re much more limited in how much you can put into an IRA, but what you can do with it is much more varied than with a 401(k) or 403(b).
An IRA can be set up at almost any major financial institution: banks, insurance companies, mutual fund companies, brokerage firms, and more, although the type of IRA you get can determine where it’s set up.
Most IRA contributions are tax deductible, as long as you meet certain conditions (the exception is a Roth IRA). When an IRA is tax-deferred, tax on the contribution and investment growth is not paid until the funds are withdrawn.
An IRA is designed to save for retirement, but unforeseen emergencies can force people to withdraw money before retirement. Early withdrawals (a withdrawal before age 59½) may be subject to a 10% tax penalty.
There are exceptions to this. If you have to withdraw money from your IRA to cover medical expenses not covered by your health insurance that exceed 7.5% of your adjusted gross income (AGI), you will not be subject to the penalty. If you are determined to have a physical or mental disability that affects your ability to obtain continued employment, you can also withdraw money from your IRA without penalty distributions.
What’s in an IRA?
The money you put into your IRA is kept in that account, and you can choose how to invest it.
An IRA can be a bit confusing at first glance, as it can be both a savings and an investment portfolio. An IRA generally gives you many more investment opportunities than an employee-sponsored 401(k).
Investing in stocks, bonds, mutual funds, index funds, and ETFs is allowed and common for IRAs, just like any investment portfolio. Investment real estate is also allowed for IRAs, but only if it is used solely as an investment and not as a property in which you live or earn rental income.
This gives you a fair amount of freedom in how your IRA funds are invested. Treat it as you would any other investment portfolio. Determine where you want to put your money, what your risk tolerance is, and how you want to diversify. Investing in stocks, over the long term, has proven to be the most likely way to earn additional money from investments.
Types of IRAs
What kind of IRA do you want? That depends on what’s available to you, but also where you want to set up your IRA and whether your employer can offer one.
These are the most popular types of IRAs.
traditional IRA
The traditional IRA is generally called that to differentiate it from a Roth IRA (more on these below).
There is no minimum amount of annual income required to establish a Traditional IRA, and as mentioned, your contributions are tax-deferred until distributed. While you’re usually limited to $6,500 in contributions, if you’re age 50 or older, you get an extra $1,000 added to your limit as you “catch up.”
You can also deduct the contributions on your taxes depending on your income. Once you reach a certain income, you can no longer fully deduct the tax, and the amount you can deduct gets smaller and smaller until you reach a certain annual income (by 2023, $116,000) and are no longer eligible for any deductions. .
Once you reach age 70½, you will no longer be able to contribute to your Traditional IRA and you will need to start taking minimum distributions.
SIMPLE ANGER
Small businesses that cannot offer a 401(k) can offer their employees a SIMPLE IRA.
To qualify for a SIMPLE IRA, your employer cannot have more than 100 employees who earn at least $5,000 a year. You, as an employee, must also have earned that much for at least two years with reason to believe that you will continue to earn that much to qualify for the account.
A SIMPLE IRA has the same 10% penalty tax as a Traditional IRA if you make distributions before age 59½, but if you have to do so within the first two years of owning the account, the penalty increases to 25%.
SEP IRA
The SEP in SEP IRA stands for “Simplified Employee Pension.” SEP IRAs are designed for self-employed or small business owners.
Instead of a set contribution limit, a SEP IRA allows you to contribute up to a certain percentage of your income each year (since you’re contributing as an employer, not an employee). He must have been working in this regard for this company for at least three of the last five years and have earned at least $600 in the last year.
Because your contributions are made as an employer and not as an employee of the business you own, contributions to your SEP IRA are subtracted from your net business income.
Roth IRA
Traditional IRAs and Roth IRAs are probably the two you’ve heard about the most. What is a Roth IRA and how is it different from a traditional one?
A Roth IRA has no minimum contribution and has the same annual contribution limits ($6,500 or $7,500 if age 50 or older). But while contributions to a Traditional IRA are made on a pre-tax basis, contributions to a Roth IRA are after-tax. This means that your contributions are not tax-deductible, but it also means that your withdrawals are tax-free. You are also not subject to tax penalties if you withdraw before retirement.
Once you reach retirement age with a Roth IRA, minimum distributions are not required, and if you still have income, you can continue contributing to it.
IRA Rollover
A rollover IRA is a very specific version. You are not contributing to your rollover IRA; rather, he’s created it so you can roll over contributions from an employer-sponsored account like a 401(k) or 403(b), usually after you leave that employer.
By rolling your 401(k) into an IRA, you not only maintain the tax-deferred nature of your contributions (at least with a traditional IRA), but you now have more flexibility with what you do with those contributions. IRA investment options are broader than most employer-sponsored retirement accounts, and now what he does with them is in his hands.
IRA contribution limits
The amount you can contribute to an IRA depends on the type you have, although some are the same. These are the contribution limits for 2023:
The limit of a SIMPLE IRA is significantly higher than that of a traditional or Roth IRA, probably because the contributions to your SIMPLE IRA come from your salary.
If you have a SEP IRA, you or your employer cannot contribute more than 25% of the compensation up to $66,000.
IRA Deduction Limits
The tax deduction you can get with your IRA is based on both the IRA you have and the income you earn. If you have a Roth IRA or a SIMPLE IRA (if you’re an employee), it’s pretty simple: You can’t deduct anything.
If you have a traditional IRA, it will also depend on whether or not you are covered by a retirement plan at work. If you are not, the limits are as follows:
- If you are filing your taxes as a single, head of household, or qualifying widow(er), you can fully deduct up to the contribution limits.
- If you are married filing jointly or separately and your spouse is also not covered by a retirement plan at work, you can fully deduct up to the contribution limits.
- If you are married filing separately and your spouse IS covered by a retirement plan at work, you can take a partial deduction if your modified adjusted gross income (MAGI) is less than $10,000, and you cannot deduct if your MAGI is of $10,000 or more.
- If you are married filing jointly and your spouse IS covered by a retirement plan at work, you can fully deduct up to the contribution limits if your MAGI is less than $214,000. If your MAGI is between $218,000 and $228,000, you can take a partial deduction that decreases the higher your MAGI. You cannot deduct if your MAGI is $228,000 or more.
If you ARE covered by a retirement plan at work, these are the deduction limits:
- If you’re single or head of household, you can fully deduct up to the contribution limits if your MAGI is less than $73,000. If your MAGI is between $78,000 and $83,000, you can take a partial deduction that decreases the higher your MAGI. You cannot deduct if your MAGI is $83,000 or more.
- If you’re married filing separately, you can take a partial deduction if your modified adjusted gross income (MAGI) is less than $10,000 and you can’t deduct if your MAGI is $10,000 or more.
- If you’re married filing jointly, you can fully deduct up to the contribution limits if your MAGI is less than $218,000. If your MAGI is between $218,000 and $228,000, you can take a partial deduction that decreases the higher your MAGI. You cannot deduct if your MAGI is $228,000 or more.
