The new year is a fresh start – and it’s a great time to take stock of where you are with your most important financial goals. For many, a secure retirement is a top priority and the beginning of the year offers an excellent opportunity to get your Individual Retirement Account (IRA) started. Let’s dive into the details, so you can see which IRA is right for you.
What Exactly Is an IRA?
An Individual Retirement Account (IRA) is an account that provides tax advantages when saving for retirement. Generally, anyone with earned income is eligible for an IRA. For 2020, the maximum contribution you can make to an IRA is $6,000, or $7,000 if you’re age 50 or older. All earnings inside a Traditional IRA grow tax-deferred, meaning you won’t pay taxes on the earnings until you withdraw them. Any withdrawals made before age 59 ½ are subject to a 10% penalty on top of the ordinary income taxes you must pay. It’s worth noting there are exceptions for making penalty-free early withdrawals, such as using the funds for a down payment on a house or covering eligible college expenses. You can also make penalty-free withdrawals if they are made equally over your life expectancy.
Contributions made to a Traditional IRA are tax-deductible, meaning they will lower your taxable income, which reduces your tax liability. However, your contributions are only fully deductible if you or your spouse don’t have access to an employer-sponsored retirement plan, such as a 401(k). Even if you participate in an employer-sponsored plan, any contributions you make to an IRA may be partially deductible up to specific income limits.
The tax advantages of an IRA can provide a boost to your retirement savings as well. By reducing your current taxes with a tax-deductible contribution, you may have more money to save towards other goals. Then, if your earnings inside the IRA accumulate tax-deferred, they can compound faster. While you will eventually pay taxes when drawing down from your IRA, conceivably, you could be in a lower tax bracket.
You can establish a traditional IRA at most financial institutions, though the fees and investment choices will vary. At Teachers, we believe it’s never too early to start saving for retirement. With our Traditional IRA Account, you can contribute your pre-tax dollars and watch your investments grow tax-deferred until retirement.
What About a Roth IRA?
A Roth IRA has a lot in common with a Traditional IRA, though the primary difference between the two is their tax treatment. With a Roth IRA, contributions are not tax-deductible. However, the earnings inside a Roth IRA grow completely tax-free, which means withdrawals are not taxed.
Anyone with earned income is eligible to establish a Roth IRA—but there are limits to the amount that may be contributed based on your income. For 2020, individuals with incomes less than $124,000 ($196,000 for joint filers) may make the full contribution of $6,000 ($7,000 for 50 and older). The maximum contribution is reduced for incomes over $124,000, and it’s eliminated for incomes over $139,000 ($206,000 for joint filers). As a reminder, 2020 contributions can be made up to April 15th.
Since contributions are made with after-tax dollars, the withdrawal rules for Roth IRAs are more relaxed than with traditional IRAs. As long as you hold a Roth IRA account for at least five years following the initial contribution, you may be able to take early withdrawals with no taxes or penalties. As with a traditional IRA, a home down payment or college expenses can use withdrawals from a Roth IRA.
Most financial institutions that offer Traditional IRAs also offer Roth IRAs. At Teachers, our Roth IRA Accounts offer a non-deductible way to start your retirement savings.
Which IRA is Right for You?
So, now that you know a bit more about IRAs, which one is right for you? As with any investment decision, the right answer depends entirely on your circumstances. A Traditional IRA can provide a more significant boost for your retirement savings if you benefit from current tax deductions and expect to be in a lower tax bracket in retirement. If you anticipate being in a higher tax bracket by the time you retire, or you want more flexibility with withdrawals, a Roth IRA may give you a better boost.
To make the right decision, we suggest thoroughly assessing your financial needs and objectives. If you need extra assistance, consider contacting a financial advisor or get in touch with our team. At Teachers, we’re here to help you plan ahead and make your money work for you — one step at a time.