Maximize Your Retirement Savings: A Comprehensive Guide to IRAs
At this time of year, it is a great time to plan for your future and get a tax deduction at the same time.? Whether you have a workplace-based retirement plan or you don’t, an Individual Retirement Account (IRA) can be a great, low-cost planning tool for your golden years.? In this edition of Miller’s Money Matters, I am going to explain:
1. What is an IRA?
An IRA is a tax-advantaged investment account that you can use to save for retirement. Technically, IRA stands for Individual Retirement Arrangement, but the ‘A’ in the acronym is colloquially referred to as an account.
2. How does an IRA work?
Using an IRA versus a regular taxable brokerage account for retirement feels similar to the difference between speeding through the E-Z Pass lane on the highway or stopping at the toll booth every 20 miles: You’re going to get where you want to go a bit faster without having to stop at the tax tollbooth every year as you would with a regular brokerage account.
When you open an IRA, you contribute funds that can then be invested in a wide range of assets — CDs, stocks, bonds, and other investments. You’re not limited to a menu of investments as you often are in a 401(k). That means you can take full control of how this account is invested.
If you don’t feel well equipped to direct (in other words, choose investments for) your IRA, it’s wise to browse robo-advisors or pick a target-date retirement fund. Both are low-cost ways to get broad-based diversification tailored to your time horizon and your risk tolerance.
No matter when you’re hoping to retire, today’s asset allocation — how you split your money between stocks, bonds, and other investments — is critical to tomorrow’s earnings. Some studies have shown that asset allocation determines as much as 90 percent of an investor’s total return. IRAs offer flexibility in adjusting those investments, too. You can move in and out of them — for example, shifting your money from individual stocks to bonds — without incurring capital gains taxes.
While you can move the money around freely, you can’t take it out early. An IRA is designed for retirement, which means that withdrawals before you are 59 1/2 will incur both taxes and a hefty penalty of 10 percent — unless you’re using the money for special exceptions such as buying your first home, paying for higher education, or setting up a business (and those exceptions come with caveats).
3. Who can set up an IRA?
A non-wage-earning spouse can save for retirement too. Provided the other spouse is working and the couple files a joint federal income tax return, the nonworking spouse can?open and contribute?to their own traditional or Roth IRA. A nonworking spouse can contribute as much to a spousal IRA as the wage earner in the family.
For tax year 2023, the annual IRA contribution limit for both Roth and traditional IRAs is $6,500. This limit rises to $7,000 in 2024. If you're age 50 or older, you can contribute an additional $1,000 annually, and the amount of this additional contribution will be adjusted yearly for inflation.
The amount of your combined contributions can't be more than the taxable compensation reported on your joint return.
If you are self-employed, a freelancer or a side-gigger, you can save even more with a SEP IRA.? If you are self-employed or have income from freelancing, you can open a Simplified Employee Pension plan—more commonly known as a SEP IRA.
Even if you have a full-time job as an employee, if you earn money freelancing or running a small business on the side, you could take advantage of the potential tax benefits of a SEP IRA. The SEP IRA is similar to a traditional IRA where contributions may be tax-deductible to the small business, not necessarily the individual —but the SEP IRA has a much higher contribution limit. The amount you, as the employer, can put in varies based on your earned income.
As the employer, you can contribute to a SEP IRA for 2023 up until the tax-filing deadline in April, after which you'll only be able to make contributions for the current year.
In 2023, SEP IRA contributions are capped at $66,000 for all individuals or 25% of your eligible compensation if you are not self-employed, whichever is lower. In 2024, the contribution limit increases to $69,000.
Self-employed people can contribute up to 20%?of eligible compensation to their account. However, this does not apply to everyone. You can refer to the Deduction Worksheet for Self-Employed in IRS Publication 560 (https://www.irs.gov/pub/irs-pdf/p560.pdf) to determine your contribution limit. The deadline to set up the account is the tax deadline. But, if you get an extension for filing your tax return, you have until the end of the extension period to set up the account or deposit contributions.
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4. What are the different types of IRAs?
IRAs come in two flavors: traditional and Roth. There are two fundamental differences between them: whether you pay taxes before contributing or after withdrawing funds, and when you are required to withdraw funds.
Traditional IRA
With a traditional IRA, you could be eligible to receive a tax deduction in the year you contribute (up to a cap on the contribution of $6,000, or $7,000 if you’re 50 or older). When you withdraw the funds later, you’ll pay taxes on the full amount you are withdrawing. Once you turn 72, you must start making withdrawals.
Roth IRA
A Roth IRA doesn’t offer the instant gratification of an immediate tax break. Instead, you’ll pay taxes on your income now, contribute it to a Roth IRA, and avoid taxes when you withdraw the proceeds when you retire. However, there is no requirement to make withdrawals from a Roth IRA.
When comparing traditional and Roth IRAs, it’s fairly common to think about your current tax status versus your tax status in retirement with the assumption that you’ll be in a lower tax bracket when you are no longer working.
However, I recommend avoiding that debate. Why? Because it’s very difficult to predict your tax bracket 30 years from today. Instead, look at this from the perspective of diversifying your tax exposure and giving that money even more time to grow and compound without the headwind of taxes. Regardless of your future tax bracket, having some assets accumulated in a Roth IRA that can later be withdrawn tax-free is worth considering.
Comparing the IRA Options is not hard.? The most affordable options for IRAs will be found at no-load mutual fund firms, online brokerages and robo-advisors. Before comparing and deciding where to open an IRA, you should consider which kind of IRA is the best fit for your needs. Keep in mind, too, that the decision between a traditional and Roth IRA is not an all-or-nothing choice. You can have both — you’ll just want to make sure your annual contributions don’t exceed the limits.
5. How to set up an IRA.
To open an IRA, you or your spouse need to have earned income from working. You can open an IRA at a wide range of places including brokerage firms, mutual fund companies, banks, and credit unions. Pay attention to management fees, commissions, and minimum opening requirements to make sure you find a good deal. In addition to the basic terms of each IRA, compare educational resources if you plan on being in the driver’s seat making your own investing decisions. Some firms offer robust tools to help you understand the market and make wise choices.
6. What are the limits that you can contribute to an IRA?
The government places limits on the amount you can contribute to all your IRA accounts, which change every few years based on inflation. If you’re under 50, your contributions are capped at $6,000 in 2021. If you’re over 50, your limit increases to $7,000.
7. Why should you set up an IRA?
The growth of the IRA is the result of the magic of compounding. Let me use this example. Let’s assume that a married couple, both age 30, contribute the maximum allowed by law today of $12,000 (which will increase in future years), plan to retire at age 70, and earn 7% on the account annually. By age 70, they will have contributed $480,000 and the IRA account can be up to $2,395,636. That tax-deferred growth is why you should set up an IRA as soon as you can.
8. What if you need help or have questions?
If you need help in determining how much you can contribute or have any other questions about the IRA concept, give me a call. This no-cost consultation can help you get on the right path to taking advantage of the tax law now and benefit from it in your golden years.
In conclusion, IRAs offer a versatile and powerful tool for retirement planning, providing a range of options to suit different financial situations and goals. Whether it's a traditional IRA, Roth IRA, or a SEP IRA for the self-employed, each type offers unique benefits and opportunities for tax savings. By understanding the different aspects of IRAs, from contribution limits to the types of investments you can make, you can make informed decisions that align with your long-term retirement objectives. Remember, the earlier you start contributing to an IRA, the more you can leverage the power of compound interest, setting the stage for a more secure and comfortable retirement. If you're still unsure about which IRA is right for you or how to maximize its benefits, seeking professional advice can provide personalized guidance tailored to your individual needs. Start planning today to build a more secure tomorrow. Get on my calendar if you need to start planning.
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