When people think of retirement, they generally think of a blissful time where they have no money worries, they can travel the world, and they can enjoy their golden years. But studies have shown that not only are people ill prepared for retirement, but a full one third have not saved ANYTHING. If you would rather be one of those that are well prepared for retirement, and thus able to actually enjoy your golden years instead of scraping by on Social Security, then you need to start an IRA.
What is an IRA?
There are actually two forms of Individual Retirement Accounts. There is the traditional IRA and the Roth IRA. Both will help you store up money that can be used later in life, and both have particular tax advantages.
Both a traditional IRA and a Roth IRA are retirement accounts. These accounts are not specifically savings, CD’s, investments, REITs, or cash accounts. They are just the shells that determine how much you can put in, when you can take it out, and how the money is taxed. Just about any form of money can be stored in an IRA, and how you do that is up to you and your financial planner.
The money that is invested into an IRA, regardless of which type, can only be withdrawn after the age of 59.5 years of age (there are certain provisions, but these accounts are retirement accounts so we will ignore those provisions for now). The money will grow tax free or tax deferred, and then it can be used during retirement. If you take the money out before you hit 59.5 years old (or basically before you’re 60), then you will be assessed a 10% penalty by the IRS.
Traditional IRA vs. Roth IRA
Most people will be better of using a Roth IRA if they meet the income requirements.
A Roth IRA is funded with money that you have already paid taxes on. This means that you make $40,000 per year and you pay taxes on that full amount. Out of your take home pay you can put into your Roth IRA as much as $5,500 (for tax year 2014, this will increase in future years). Once the money is in the IRA, it grows tax free (rate of growth depends on your investment choices). After you are 60 years old, you can sell those investments and withdraw the money. Since you already paid taxes on it, any money that you take out is tax free.
A traditional IRA works a little differently. You can still only put in $5,500 this year, but the money is deducted off your income. So if you made $40,000 and you fully funded your traditional IRA, you will only pay taxes on $34,500. The caveat is, however, that you will eventually pay taxes on the money. Anything that you withdraw from your IRA is taxed at your current tax rate (that is the rate during the year which you withdraw the money). Plus, there is one more detail. Once you hit age 72, the government requires that you withdraw some of the money. These required minimum distributions are designed so that, based on your life expectancy, some money comes out each year.
IRA’s are a great way to invest in yourself. And let’s face it, the way Social Security is going, there may not be nearly enough left to cover your living expenses. So before it gets too late for you (investing early is always better than investing late), start up your IRA. Talk to a financial planner about the best option for you, and get your money into the market. Your retired self will thank you.
If you are looking for an accountant in Billings, Montana, Practical Taxes is where you should go. Practical Taxes knows taxes, business, and everything in between.
Practical Taxes is a full service accounting firm in Billings, Montana. We can help you get the most from your taxes, and make sure that you will get the maximum refund every year. But we don’t just do taxes! We can help with your bookkeeping, payroll, bank reconciliation, budgeting, and more. Give us a call at 406-894-2090 to learn more.