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Retirement Planning

Understanding IRAs

An IRA is a great way to save for retirement. This article covers the basic types and how they work.
These days, people are living longer than ever, which means retirements are lasting longer than ever. To make sure you have enough money, it's important to start saving as soon as possible. And one way to do that is with an Individual Retirement Account, or IRA.

Setting up an IRA

IRAs are not work retirement plans. You can open these accounts through an advisor and don't need to go through your employer. It's typically easy to set up your account- and you can allow your broker to have as much - or as little - control over your investments as you choose.

Contributions

The IRS limits how much you can invest in an IRA each year. If you're younger than 50, you can invest up to $5,500 into an IRA . If you're 50 or older, you can invest up to $6,500 a year. Even better? When you add money to a Traditional IRA, you'll get a tax deduction for your contribution. Now you're saving money for the future while also bringing down this year's tax bill. The Roth IRA doesn't offer a tax deduction for your contributions.

Taxes on withdrawals

You can start making withdrawals without penalty from your IRA as soon as you turn 59 ½, even if you're not working. When you take a withdrawal from a Traditional IRA, you'll owe income tax on the withdrawal. But with a Roth IRA, you already paid income tax on this money up front, so the withdrawal is tax-free. This means you'll never have to pay income tax on your investment earnings if you are 59½ or older.

Early withdrawals

IRAs are retirement plans and that's what the IRS wants you to use them for - at least until you turn 59½ . If you want to take money out before then, it counts as an early withdrawal. The IRS charges an extra 10 percent penalty on early withdrawals which can destroy your investment return. While there are a few special situations when you can avoid the penalty, like paying for excess medical bills and college expenses, generally once you put money in an IRA, you should try to keep it there until retirement. 

Compare a Traditional IRA to a Roth IRA: Which is better for you?

Traditional IRA

Income limits: There are only income limits only for individuals with retirement plans at work. Otherwise, there are no income limits.

Tax status during contribution phase: In most cases, contributions and earnings are tax deferred.

Tax status during distribution phase: Withdrawals and earnings are taxable at this stage.

Distributions without penalty: These are typically eligible at 59 ½. 

Withdrawal for home down payment: Owners can withdraw up to $10,000 for the down payment on the purchase of a first home with certain restrictions.

Withdrawal for education expenses: An individual can withdraw for qualified higher education expenses of the owner, children and grandchildren. This is the same for both Roth and Traditional IRAs

Withdrawal for medical expenses: An owner can withdraw for qualified, unreimbursed medical expenses provided they exceed a certain percentage of their adjusted gross income. They can also withdraw for medical insurance if they are unemployed or disabled.

Potential withdrawal penalties: Withdrawals before 59 ½, if not because of an allowable exception, may be subject to a 10% early withdrawal penalty.
 

Roth IRA

Income limits: Individuals with certain income levels are not eligible for Roth IRAs.

Tax status during contribution phase: Contributions are made with after-tax dollars..

Tax status during distribution phase: Withdrawals and earnings are generally tax free.

Distributions without penalty: You’re typically eligible at 59 ½ as long as contributions have been held for 5 years (from January 1 of the year of first contribution).

Withdrawal for home down payment: Owners can withdraw up to $10,000 for the down payment on the purchase of a primary home provided you have not owned a home in the previous 24 months and your have held the IRA for a minimum of 5 years. Certain other restrictions apply.

Withdrawal for education expenses: An individual can withdraw for qualified higher education expenses of the owner, children and grandchildren. This is the same for both Roth and Traditional IRAs.

Withdrawal for medical expenses: An owner can withdraw for qualified, unreimbursed medical expenses provided they exceed a certain percentage of their adjusted gross income. The owner can also withdraw for medical insurance if they are unemployed or disabled.

Potential withdrawal penalties: Withdrawals of earnings before 59 ½, if not because of an allowable exception, may be subject to a 10% early withdrawal penalty. Contributions can be taken out early without taxes or penalties.

 

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