Individual retirement accounts (IRAs) are one tool in the retirement planning toolbox that help you save money for retirement in a tax-advantaged way. But many are underutilizing them.
When it comes to saving for retirement, you might already be on your way with automatic contributions into a 401(k) account. But that’s not your only retirement account option.
Whether you’re just starting your retirement planning journey or are a seasoned investor, let’s dive into three ways to understand IRAs, and how you can make them a part of your ongoing retirement plan. Here’s what you need to know.
1. Understand the Basics
The first step in demystifying IRAs is to understand the basics. There are two main types of IRAs: traditional and Roth. With a traditional IRA, you contribute pre-tax money, which helps reduce your taxable income for the year. The money grows tax-deferred until you withdraw it in retirement, at which point you pay taxes on the distributions.
With a Roth IRA, you contribute after-tax money, but the money grows tax-free and withdrawals are tax-free in retirement. It’s important to note that there are contribution limits for both types of IRAs, and the rules can change from year to year. For the 2023 tax year, the contribution limit for both traditional and Roth IRAs is $6,500 for individuals under 50 years old, and $7,500 for those who are 50 or older (a $500 increase from 2022).
Another important aspect to understand about IRAs is that they include required minimum distributions (RMDs). Once you reach age 73, you are required to take a certain amount of money out of your traditional IRA each year. If you don’t take the RMD, you may face significant tax penalties. Roth IRAs don’t have RMDs since the money grows tax-free, but beneficiaries who inherit a Roth IRA may be required to take distributions. Understanding these basics is just one step you can take to demystify IRAs.
2. Seek Advice
If you find yourself overwhelmed or confused about IRAs, seeking advice can be incredibly helpful. One of the best resources for getting advice on IRAs is through a financial advisor. A financial advisor can help you understand the pros and cons of each type of IRA and help you decide which one is best for you. They can also help you determine how much you should be contributing and how to invest the money within the account.
When choosing a financial advisor, it’s important to look for someone who is a Fiduciary. A Fiduciary is legally obligated to act in your best interest, which means they won’t try to sell you financial products that you don’t need or that aren’t suitable for your situation. The IRS website is another excellent resource. As it has detailed information about the rules and regulations surrounding IRAs.
It’s essential to remember that everyone’s financial situation is unique, so what works for one person may not work for another. Seeking advice from a financial advisor or using online resources to learn about IRAs can help you make informed decisions that are tailored to your specific needs and goals.
3. Start Small
Finally, one of the best ways to demystify IRAs is to start small. You don’t have to max out your contributions right away or invest in complex financial products. You can start by opening a basic IRA account and contributing a small amount each month. As you become more comfortable with the process, you can increase your contributions and explore more complex investment options.
One of the benefits of starting small is that you can get into the habit of saving regularly. Consistent contributions, no matter how small, can add up over time and help you reach your retirement goals. If you’re new to investing, it can be daunting to put a significant amount of money into an IRA. Starting with small contributions can help you get comfortable with the process and the potential ups and downs of the market.
It’s important to note that while starting small is a great way to begin saving, you should aim to increase your contributions over time to help maximize your retirement savings potential. As your financial situation improves, consider increasing your contributions, so you’re consistently saving more.
Setting Up Your IRA
Most people are eligible to open and contribute to an IRA, and they are fairly easy to set up. To summarize:
- To open and make contributions to a traditional IRA, you (or your spouse) just need to earn taxable income.
- There’s no age limit for opening or contributing to a Roth IRA, but your ability to contribute based on your tax filing status and the amount of your modified adjusted gross income.
- You can easily open an IRA through many banks or brokerage firms. And most financial institutions make managing your account easy to do.
- You can manage your investments on your own or work with a financial professional to help guide your strategy.
- Keep in mind that your combined contribution to traditional and Roth IRAs is $6,500 for the 2023 tax year. You can contribute an additional $1,000 if you’re 50 or older.
Demystifying IRAs is all about understanding the basics, seeking advice, and starting small. With a little bit of knowledge and some professional guidance, you can navigate the world of IRAs and start saving for a more secure retirement.
At Johnson Wealth and Income Management, we can help Iowans like you manage your wealth and plan for the future. We offer a range of services such as retirement planning, risk management, tax planning, and more. Ready to take the next step?
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