This is my first blog post…ever. I really have no idea where to start. Ironically I work with investors everyday who have no idea where to start.
One of the best places for any investor to start is with an Individual Retirement Account (IRA). They are available to almost everyone and the benefits are great. Under current IRS guidelines, any individual with earned income may contribute 100% of their income or up to $5,500 per year, whichever is less. If you are over the age of 50 the contribution limit increases to $6,500 per year.
Once the money is invested into the IRA any dividends, interest, and capital gains grow tax-deferred. In simple terms, you don’t owe taxes every year on this income. This tax deferral allows you to reinvest more of your earnings every year increasing your opportunity to outperform investments in non-retirement accounts.
What’s the catch? Money invested into an IRA needs to stay in an IRA until age 59.5 or else it will be penalized. Some exceptions apply under IRS code 72(t) and Roth IRA’s have some different rules outlined below. Remember, this is a retirement account so its money you do not intend to touch anyway.
A question I hear often is why I would use an IRA if I have a retirement plant at work. Most company plans provide the same tax benefits of an IRA. A big difference is funding. Employer sponsored plans usually are funded through salary deferrals, meaning it comes right out of your check. I love this forced savings. As an added plus, many employers will offer a match to your contributions.
With an IRA you can set up a periodic investment plan creating a forced savings strategy and the ability to fund at your convenience. This way if you get a bonus at work or have a little money left over at the end of the month, you can invest the money anytime you have a surplus.
To help make the decision even easier, you don’t have to choose! You can have both a retirement plan at work and an IRA. You can save as much as you feel comfortable into your employer plan and then if you have extra savings at the end of the year, you can put this money into an IRA.
There are two types of IRA’s an investor will want to consider. Each person will want to examine their own situation carefully but I will highlight the major differences and qualifications.
Traditional IRA
Contributions are made with pre-tax dollars and earnings grow tax free. When the money is withdrawn in retirement, it is taxed as ordinary income. In 2016 you may deduct your contributions from your taxable income if your income is under $61,000-$71,000 (single) or $98,000-$118,000 (married filing jointly). If your income falls within in the income ranges, you will receive a partial deduction. If you haven’t started to withdrawal money by age 70.5, the IRS requires you begin to take minimum distributions.
Roth IRA
Contributions are made with after-tax dollars and earnings grow tax deferred. Your contributions may be removed prior to age 59.5 without taxes or penalties but earnings must remain in the IRA unless you wish to pay penalties. When the money is withdrawn after 59.5, no taxes are owed on earnings provided they are held in the account for at least five years.
If your income is outside the ranges of a Traditional IRA or Roth IRA, there are still ways you can use an IRA. This may include a strategy like a non-deductible IRA or back door Roth. There are also other types of IRA’s for small business owners and self employed investors.
Once you have funded your IRA, you have complete autonomy and flexibility over where it’s held and what it invests in. You may invest it in any stocks, bonds, CD’s, mutual funds, or ETF’s you may like. There is usually little to no cost to establish one. The company holding your IRA will generate the necessary tax documents to file with your tax return. You have until each year’s tax filing deadline to make your contributions (for 2016, you would have until April 18th, 2017).
This is all high level and your specific situation may involve additional complexities. I recommend asking a CERTIFIED FINANCIAL PLANNERTM or qualified tax advisor any questions regarding your personal situation. The key takeaway though is you likely have an easy, low cost, efficient way to save and invest for retirement.
Happy Investing.