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Guide to IRAs

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When you think about your retirement, you might picture yourself on a beach or driving cross-country in an RV, with no worries in sight. 

But even if your idea of slowing down includes becoming a professional skydiver (hey, whatever feels right), you’re going to need to set aside a chunk of money beforehand to help make your retirement dreams a reality. 

This is where individual retirement accounts – aka IRAs – could help. They may not be the only way you save for your second act. But their possible tax benefits and age-based withdrawal rules could make them a worthwhile part of your overall savings portfolio.

There are several types of IRAs to consider, and here we focus on three: Traditional, Roth and SEP. They have different rules, but they all exist to help you save money to use when you close in on retirement age or later. This guide walks through their differences and things to keep in mind when you’re ready to open one. 

Already contributing to an employer-sponsored retirement plan, like a 401(k)? Stick around – you may be able open an IRA, too.

With a Traditional IRA, you contribute money on a pre-tax basis, and your savings grow tax-deferred.

What is a Traditional IRA?

In this case “Traditional” doesn’t mean conservative, either to describe the owner or how the funds are invested.

It just means this type of retirement account has a few specific rules:

Deposits and taxes

With a Traditional IRA, you contribute money on a pre-tax basis, and your savings grow tax-deferred.

One perk of these plans is that you may be able to deduct your pre-tax contributions from your taxable income. How much can you write off? That’ll depend on several factors, such as your income and whether you have access to a retirement plan at work. If you have questions, your tax advisor will be able to help you out. 

The caveat: Even if you can deduct your contributions now, you might still be on the hook for taxes later. In most cases, you'll be required to pay taxes on money you withdraw from your Traditional IRA account in retirement unless certain qualified charitable distributions are made from the account. 

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Traditional IRA withdrawal rules

So you’ve squirreled away a nice chunk of money and you’re ready to hang up your work cap, then hit the beach or climb into the driver’s seat of that RV. Can you dip into that IRA account right away? It depends.

You can start taking out money from a Traditional IRA once you’re 59½-years-old. When you make a withdrawal, you’ll just have to pay income tax on it. Of course, you could take funds out earlier – but you’ll likely get hit with a tax bill plus a 10% penalty. There are also rules about making required withdrawals every year once you’re 72. 

Important note about withdrawal rules: If you started researching IRAs before March 2020, this information may feel a little off and with good reason: Congress passed the CARES Act, temporarily suspending some of these requirements during the early stages of the Covid-19 pandemic. We have details about those changes here and recommend keeping in touch with your financial advisor so you know when and how the rules may continue to change.

What is the contribution limit for a Traditional IRA?

The IRS has a cap on how much you can sock away in retirement accounts. In 2021, the annual limit for Traditional IRAs is $6,000 or $7,000 for savers age 50 and above. 

How do you open a Traditional IRA?

You can open a Traditional IRA account through a bank, brokerage or an IRA provider. Note that some firms require a minimum investment amount to open an account, so you’ll want to do a little research beforehand to compare your options.

When you have a Roth IRA, the money you put in is taxed before it goes into the account.

What is a Roth IRA?

Fun fact: This type of retirement account was named after former Senator William V. Roth, Jr., from Delaware. And the name isn’t the only difference. Here’s how Roth IRAs compare: 

Deposits and taxes

When you have a Roth IRA, the money you put in is taxed before it goes into the account. While that might seem like a missed opportunity to save on taxes upfront, the benefit could come later: When you retire, you can withdraw your money tax-free (as long as you meet certain requirements). 

Roth IRA withdrawal rules

Unlike Traditional IRAs, you can usually withdraw your Roth IRA contributions (i.e., the money you deposited, not the money you’ve earned) at any time, for any reason, tax and penalty-free. So, if you like the idea of being able to access the money without having to hit a certain age, this feature could make a Roth IRA appealing. 

Still, consider speaking to a tax professional before dipping into your funds early. You may have to pay taxes and penalties on your earnings (the money you’ve made on your contributions). However, there are several tax exceptions, which you can find on the IRS website.

Are there contribution limits for a Roth IRA?

Roth IRAs and Traditional IRAs have the same contribution limits. In 2021, that means you can put in $6,000, or $7,000 if you’re 50 and older.

Good to know: Once your income hits certain levels, the amount you'll be able to contribute to a Roth IRA may decrease or even be eliminated. For 2021, as a single tax filer, your contribution allowances are reduced once you hit $125,000, and you become ineligible at an income level of $140,000 and above. For those who are married filing jointly, contribution allowances drop at $198,000 and disappear at $208,000. 

How do you open a Roth IRA? 

Again, it’s usually straightforward. As long as you’re eligible, you can open a Roth IRA just as you would a Traditional IRA: through a bank or brokerage that offers this type of plan. If you have a Traditional IRA with a specific provider, you’ll likely be able to open a Roth with them as well. 

There's a lot to know about Traditional and Roth IRAs, and we're just getting started. If you want to learn even more about the benefits and differences, check out this article.

A SEP IRA is similar to a Traditional IRA in that your money grows tax-deferred until retirement, and contributions are tax-deductible up to a certain amount.

What is a SEP IRA?

If you’re self-employed or a small business owner, you may be eligible to open another type of retirement account. It’s called the Simplified Employee Pension plan, or SEP IRA. If you own a business in addition to having regular job, you may still be able to open this type of retirement account. One big benefit is that these plans usually come with higher contribution limits, which we’ll get into below. 

A SEP IRA is similar to a Traditional IRA in that your money grows tax-deferred until retirement, and contributions are tax-deductible up to a certain amount.

What are the contribution limits for a SEP IRA?

You may be able to put more money into a SEP IRA than a Traditional or Roth IRA. For the 2021 tax year, an employer can contribute up to $58,000 or 25% of an employee’s salary (whichever is less) into a SEP IRA account. You can choose how much you want to contribute, and once you start, you're not required to contribute every year. 

What’s more, as a business owner, you can make these pre-tax contributions for yourself. But there's one caveat if you have employees: The IRS says employers must also contribute the same percentage on behalf of all eligible employees. 

That means if you want to put 20% of your own salary into a SEP IRA, you must contribute 20% of any eligible employee’s salary to their SEP IRA, too. For this reason, these plans are usually recommended for smaller businesses with no or few employees.

How do you open a SEP IRA?

Do your research to find a SEP IRA provider that will work best for you. Once you've decided where you'll open your account, the IRS requires you to take several steps. You can learn more about the details here

Once SEP IRA accounts are established, each employee will own and control their accounts, including investment decisions. 

SEP IRA withdrawal rules

Withdrawal rules for SEPs are a lot like the ones for Traditional IRAs, including how the 2020 CARES Act temporarily changed the rules around withdrawals. So, our advice about checking in with your financial advisor is the same – keep in touch to know how and if the rules are changing.

In general, though, these were the pre-2020 rules:

  • Penalty-free withdrawals (that you may have to pay income tax on) start after age 59 ½.
  • Possible tax bill and a 10% penalty if you make withdrawals before you turn 59 ½.
  • Required Minimum Distributions typically start once you reach 72.

Can you have more than one type of IRA?

Now that you know more about the different IRA plans available, you may be wondering if you can open more than one account. (And dreaming about those retirement goals, but let’s stick to the money stuff for now!) 

The good news: Yes, you can fund more than one. So, if you want to open a Traditional and Roth IRA, you can do that. But, there is a rule to know about: The contribution limits we ran through above refer to the total amount you can contribute across your IRA accounts in a year. We go through the specifics here.   

Can you have joint IRA accounts? 

Joint IRA accounts work differently than, say, a joint checking account where both people listed on the account own it. 

With a joint IRA, one person owns the account, but another person makes contributions on the owner’s behalf.

Also important to know:

  • They are available to married couples and sometimes referred to as “Spousal IRAs.”
  • You need to file a joint tax return to open a joint IRA.
  • The contributions to the joint/spousal IRA have to be made from earned income and contributions can’t exceed combined earned income.
  • The contributor can still make contributions to their own IRAs, but their contributions can’t exceed limits set by the IRS: $12,000 for a couple or $14,000 if both spouses were over 50 at any point during the year.

Is it ever too late to open an IRA account?

If you're nearing retirement age, you might be wondering if you missed your opportunity to get an IRA account. But the saying "Better late than never" certainly applies here. So if you’re behind on saving for retirement, you may be able to accelerate that through an IRA.

Here’s how it works: People over the age of 50 can begin making “catch-up contributions” on Traditional and Roth IRAs, which allow you to exceed the normal maximums. The same can’t be said for SEPs, since they can only be funded with employer contributions, according to the IRS’ site. But, there may be a workaround to this, in the form of Traditional IRA contributions. In short: another opportunity to tap your financial advisor for some info.

Good to know – it’s almost never too early, either

In fact, a minor or young adult can have and fund a Traditional or Roth IRA provided they’ve earned income during the year. If your child is a minor, the account can be set up in their name, but it will require a custodian or guardian to control it until they reach the legal age of consent in your state (usually 18 or 21). 

Parents or other family members can help contribute to a child’s IRA by gifting an amount to the child, up to the amount of income the child has earned.

So, if 16-year-old Molly earns $3,000 at a summer job and does not invest the money in an IRA, her grandmother can gift her savings by providing Molly up to $3,000 to contribute to an IRA. Now, that's the gift that keeps on giving!

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