A quick look into two retirement savings plans
Photo by Obi Onyeador on Unsplash
An individual retirement account (IRA) is a tax-advantaged investment account used for retirement savings. IRAs were first established in the United States by the Employee Retirement Income Security Act of 1974.
IRAs are typically not employer-sponsored due to the traditional and Roth 401(k) already taking care of that side of retirement saving. An individual who already has a 401(k) may look to create an IRA for themselves to increase their retirement savings further.
As of 2020, the maximum contribution an individual can make to an IRA is $6,000 per year. It is $7,000 per year if you are over the age of 50. If you withdraw money from an IRA before the age of 59.5, you may be subject to an early-withdrawal penalty of 10%. Exceptions that avoid the early-withdrawal penalty include death, disability, and qualified higher education.
When it comes to the different kinds of IRAs, there are 4 main types, which are the traditional IRA, the Roth IRA, the SEP IRA, and the SIMPLE IRA. With the traditional and Roth IRAs being the most common, those two will be the focus here.
Traditional IRA
A traditional IRA involves making contributions with post-tax money that you might be able to deduct when it is time to file taxes. In most cases, earnings are tax-deferred until you withdraw from your traditional IRA after the age of 59.5.
When it comes to being able to deduct your contributions to your traditional IRA when it is time to file taxes, you should know if the traditional IRA you are contributing to is deductible or nondeductible.
With a deductible account, you can lower your current tax bill by deducting your contributions to your traditional IRA. With a nondeductible account, you cannot deduct your contribution to your traditional IRA. In a deductible account, your earnings are tax-deferred, while in a nondeductible account, your earnings are tax-free.
Nondeductible IRAs are typically more tailored towards the income of individuals who are too high for the Internal Revenue Service (IRS) to allow them to make tax-deductible contributions. As an individual in 2020, you cannot make deductions for contributions to a traditional IRA if your modified adjusted gross income (MAGI) surpasses $75,000 per year.
Roth IRA
A Roth IRA involves making contributions with post-tax money. When it comes time to withdraw money after the age of 59.5, contributions and earnings are withdrawn tax-free. The Roth IRA was introduced as part of the Taxpayer Relief Act of 1997 and is named after William Roth, U.S. Senator from Delaware.
A Roth IRA is best suited for an individual who expects to be in a higher tax bracket when it comes time to withdraw money. With this expectation, it is important to understand the income limits of a Roth IRA.
As an individual in 2020, you can make a full contribution to a Roth IRA if your MAGI is below $124,000. You can make a partial contribution to a Roth IRA if your MAGI range from $124,000 to $139,000. If your MAGI is over $139,000, you cannot contribute to a Roth IRA.
When it comes to creating and contributing to an IRA, it is best to work with a certified professional for the best set-up for yourself. By working with a certified professional, you are positioning yourself for long-term financial success. Reading stuff online is great but working with someone with certifications and years of experience is even better.
Saving for retirement is not always the most interesting topic to talk about, but it is important to understand. Whether you are employed or self-employed, being understanding of your retirement savings options is important. An IRA might not be the right form of retirement saving for you now, but it may be some time in the future.
Check out The Tunji Letter to stay connected.
Leave a Reply