If you are self-employed, or your employer doesn’t offer a retirement plan, you can still save for retirement using an Individual Retirement Account (IRA). As long as you have earned income, or happen to be married to someone with earned income, you can open and contribute to an IRA.
Most people think that an IRA is an investment, but it is not. Rather, it is a shell account that can hold a wide range of different investments. Some of the most common investments held in IRAs are cash, money market accounts, stocks, bonds, CDs, mutual funds, ETFs, and other investment vehicles, sometimes even real estate.
IRAs vs. 401ks
There are both similarities and differences between IRAs and 401ks. The primary similarities are as follows:
- Both IRAs and 401ks offer tax benefits for people who want to save for retirement; and
- Both were designed with the hope that you will invest the money saved in your account so that it grows enough to cover your spending needs in retirement.
The two key differences between IRAs and 401ks are:
- While an IRA is established by an individual person, a 401k is established by an employer on an employee’s behalf; and
- IRAs are designed to let you save for retirement solely through your own contributions. But with a 401k, the employer makes regular contributions on an employee’s behalf, who may then choose to match a percentage of the employer’s contributions, or not.
Traditional IRAs vs. Roth IRAs
The rest of this article will focus on the two most commonly used forms of IRAs:
- Traditional IRAs; and
- Roth IRAs
A traditional IRA allows you to make contributions with “pre-tax” income. This means that you can deduct contributions from your taxes in the year that they are made.
You will only have to pay taxes on money that you contribute to a traditional IRA when you take it out of your IRA during retirement. This makes a traditional IRA a better choice if you believe that your tax rate will be lower at retirement than it will be when you are making the contributions.
Contributions to a Roth IRA are made with “after-tax” income. Meaning that you don’t get a tax break on contributions in the year that they are made. However, because you’ve already paid taxes on that money, you can withdraw it from your IRA tax-free during retirement.
Perhaps the biggest advantage a Roth IRA offers is that you don’t have to pay taxes on funds you withdraw from your IRA account during retirement, nor on any gains that your contributions have produced. This is especially advantageous if you believe that you will benefit more from tax-free growth on your investments than tax-free contributions.
Yearly Contributions Limits
As of 2020, individuals who are under 50 years of age can contribute up to $6000 per year to an IRA. Those who are age 50 and older can contribute $7000 per year. However, your earned income for the year must be equal to or greater than your contribution. If your earned income is less than your yearly contribution limit, you can only contribute up to the amount of your earned income.
IRAs and Early Withdrawals
You are not supposed to withdraw the money in your IRA until you retire. But, there are certain circumstances where you can make an early withdrawal or borrow against your IRA.
However, penalties apply to early withdrawals and every situation has its own set of rules. An experienced attorney can explain these rules in detail and help you understand how you may be able take advantage of them if need be.
Contact an Experienced Estate Planning Attorney
There are many advantages to including an IRA in your overall estate plan. For more detailed information on IRAs, consult with a knowledgeable estate planning attorney.
An experienced attorney can provide you with more detailed information regarding the pros and cons of traditional IRAs, Roth IRAs, and other types of IRAs, as well as, explain how each can be used to address your specific estate planning and retirement needs.
To learn more about how to plan for your estate, contact an experienced estate planning attorney to arrange a free consultation. For help getting started with your estate plan, contact us or sign up below for one of our events.