An individual retirement account (IRA) can be one of the best investments you make in your future, but there are many misunderstandings about what IRAs are, how they work, and how to make the most of this employee benefit. An IRA isn't meant to replace other types of retirement investments and benefits, but rather to augment them.
Get Started Today
Studies have shown that people often wait until they're in their mid-30s or even 40s before they start taking retirement savings seriously. A 2018 survey performed by GOBankingRates found that 39% of millennials had less than $10,000 saved and that women tend to save less than men. This dropped to just over 34% for the age 35 to 54 demographic, but 23% of those age 55 or older had saved at least $300,000—a big difference.
This is scary considering that some analysts believe that present-day Social Security benefits will be depleted by 2034.
Annual Limits on Contributions
The Internal Revenue Service (IRS) puts a cap on annual contributions to IRAs: $6,000 as of 2019, with an extra catch-up allowance of $1,000 if you're age 50 or older. The combined contributions can't exceed the IRS approved amount if you have both a workplace retirement savings account and a personal IRA.
Consider contributing at least an additional $3,500 to your health savings account as well to maximize your tax savings.
Types of IRAs
You're not limited to the IRA plan your employer offers; there are a number of different types of IRA plans to choose from.
The most common types of IRAs are traditional and Roth. Some plans are fully funded by employees, fully funded by employers or a combination of both. Most employers offer IRAs that are funded by employees, then contributions are matched by the company. These are the most preferred IRAs.
Companies might also choose to require employees to self-fund IRA plans and only offer extra money at the end of the year through a SEP or profit-sharing program. Self-employed individuals can also choose a SEP IRA or a SIMPLE IRA to start saving earnings for retirement, so this option isn't limited to just those with traditional jobs.
Contributing for Your Spouse
A married individual can also contribute the maximum annual amount into an IRA account for his spouse. This is referred to as a spousal IRA. The spouse doesn't have to be employed. This option can double the retirement earnings of a married couple. A couple over the age of 50 could put away $14,000 a year using this method.
Some rules apply, however. You must file a joint married return to elect this option, and the working spouse must have income at least in excess of the combined contributions.
Rolling Over Instead of Cashing Out
You'll be given a choice to either cash-out or roll your funds over into a 401(k) or another IRA if you leave an employer and you have a retirement fund there of any type. It's always preferable to roll your funds over directly to a retirement account with your new employer if possible or with your bank.
If you cash out your funds, you can expect to pay at least 30% in administrative fees and taxes. The plan administrator is required to withhold 20% for taxes alone and send this to the IRS.
Using Your IRA
The IRS requires that individuals begin using their IRA funds through required minimum distributions by age 70 1/2. It's possible to start collecting Social Security retirement benefits at age 62 and continue working part-time and contribute to an IRA until age 70 1/2, but your earnings will reduce your Social Security benefits until you reach full retirement age.
This short period can nonetheless help you to make up lost income earning potential. It's far better to have a plan for how the IRA will be invested at retirement age. For example, someone anticipating retirement at the age of 62 might want to start looking into another type of transferable wealth to be left as an inheritance.
Protection From Debt Collectors
Putting money into an IRA can protect your assets if you're in serious debt and considering bankruptcy. The government protects up to $1 million of retirement funds from judgment creditors when the money is held in an approved IRA.