9 IRA FAQs: Invest In Yourself, Educate Yourself
Retirement planning is an essential part of rounding out your financial portfolio and investing in your future. While there are various methods of savings vehicles, one of the most common retirement plans is an Individual Retirement Account (IRA). IRAs are not the same as 401(k)s or other employer-offered plan.
Below are answers to nine of the most commonly asked questions regarding IRAs.
1. Why Should I Have An IRA?
IRAs function as a savings vehicle designed specifically for retirement. Unlike other savings accounts, IRAs follow their own rules regarding contribution amounts, withdrawal amounts and taxes. The regulations on IRAs are in place to protect your assets for the future, ensuring that once retirement hits, the account holder has a cushion.
2. Should I Open A Roth Or Traditional IRA?
Roth and Traditional IRAs are both vehicles for retirement savings, but they do function differently. Choosing between the two is a very important decision, and while conversions can be made to switch from one to the other, the initial choice should not be taken lightly. Because of how the accounts work and their specific benefits, the choice is ultimately an individual preference based upon personal/situational specifics.
The main differences between the two account types are: income limitations, tax incentives and withdrawal regulations.
- Roth IRA Breakdown: Anyone with earned income below a specific amount ($181,000 for married filing jointly, $114,000 for singles in 2014) can contribute, in the year income is earned. Tax-free growth; taxed on the front; no tax deductions; tax rate determined by the current tax rate. No minimum withdrawal amount ever; tax- and penalty-free withdrawals throughout account lifetime.
Traditional IRA Breakdown: Anyone under 70.5 years old with an income can contribute. Tax-deferred growth; taxed on the back; annual tax deductions available for annual contributions; tax rate determined by rate in retirement. Minimum withdrawal amounts beginning at 70.5; earlier withdrawals can begin tax- and penalty-free at 59.5 years old.
One benefit of a Traditional IRA is that the account is not as easily accessible, designating the amount saved for retirement years and ensuring that the account does not dry up before then.
3. Can I Withdraw From My IRA Before I Retire?
Yes. For Traditional IRAs, withdrawals before 59.5 years old may come with taxes and penalties. At 70.5, withdrawals (for a minimum amount) are mandatory.
For Roth IRAs, withdrawals are tax- and penalty-free and can be made at any point.
4. How Much Can I Contribute To My IRA?
There are contribution limits based on age and income levels.
For Roth IRAs, the 2014 contribution maximum is $5,500 for individuals under 50. Additionally, the amount contributed cannot exceed the total annual taxable income.
For Traditional IRAs, the 2014 contribution limit is also $5,500.
An additional $1,000 can be contributed for individuals 50+.
5. Who Qualifies For An IRA?
Anyone with taxable income can qualify.
For Roth IRAs, contributions can be made any year that taxable income is earned. The stop-and-go contribution benefit makes Roth IRAs especially appealing for minors and low-income earners.
6. Should My Kids Open An IRA?
If your child has taxable income, opening an IRA may be a financially savvy option.
7. Do I Pay Taxes On My IRA Contributions?
One way or another, IRAs are taxed. The specifics boil down to the type of IRA you invest in.
Roth IRA contributions are taxed on the front end. Because contributions are not tax-deductible, the amount contributed is factored into your annual income.
Traditional IRA contributions are tax-deferrable. Tax deductions for contributions to Traditional accounts can be made, and therefore, the contributed amount is not factored into annual income for taxation purposes.
8. Do I Pay Taxes On My IRA Growth?
As with contribution taxes, Roth and Traditional IRAs follow different regulations.
Since Traditional IRAs are taxed on withdrawal, yes – the IRA growth is taxed for Traditional accounts.
Since Roth IRAs are taxed as income prior to contribution and not taxed on withdrawal, no – the IRA growth is not typically taxed for Roth accounts.
9. What If I Don't Need My IRA Once I Retire?
IRAs can be inherited to a beneficiary if the original account holder dies and the account is willed, in the estate/trust documentation or beneficiaries are listed in the IRA account documents. A Wells Fargo piece stated, “This approach defers the tax bite, lengthens the time that earnings grow tax-deferred and/or tax-free, and can increase the value of the inheritance (if certain conditions are met).”
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