Taking Full Advantage Of IRAs

Individual Retirement Accounts (IRAs) were first introduced in 1974 to help with retirement planning. Since then, IRAs have gone through several revisions, making them one of the best ways to save for the future. Surprisingly, only 14 percent of U.S. households currently contribute to one! Given the great benefits, an IRA should be part of one’s financial plan whether you are just starting out, in the middle of your working years or headed toward retirement.

What is an IRA?

An IRA is a form of retirement plan with important tax advantages that helps shelter your money. Depending on the type of IRA you choose, you can either save on taxes today or in retirement. An IRA is not an investment type of product. You can think of it as a suitcase that can hold almost any type of investment, such as stocks, bonds, mutual funds, CDs, cash or alternative investments. You can contribute up to $5,000 per year, or $6,000 if you are over the age of 50. You have until the tax deadline to contribute for the previous year.

Why contribute to an IRA?

With the future of Social Security questionable and company pensions becoming increasingly rare, IRAs are now one of the main ways to save for retirement. Even if your employer has a retirement plan, it may make sense to invest in an IRA. Earnings in an IRA grow tax-deferred or tax-free. This means that the earnings and gains are not taxed every year, allowing more money to compound and grow. Also if you move jobs, you can roll your employee retirement assets into your IRA, giving you the freedom and flexibility to invest as you see fit.

Roth IRA vs. Traditional IRA

For a traditional IRA, contributions are fully tax deductible as long as you meet certain income thresholds. You will not be taxed on the account until you start making withdrawals, which you can start at age 59-and-a-half. You are required to take “required minimum distributions” or withdrawals once you reach the age of 70-and-a-half.

For a Roth IRA, contributions are not tax-deductible, but your withdrawals are tax-free as long as your account has been open for five years and you are at least 59-and-a-half. There are no required minimum distributions for a Roth. To qualify for a Roth, your income must meet certain limits. For 2012, your income cannot exceed $110,000 if you are single, and $173,000 if you are married for full contributions.

Talk to a tax consultant or a financial adviser for more information on both types of IRAs to see which type of IRA may be right for you. If you believe your income taxes will be higher in retirement, a Roth may be a good fit. If you believe your taxes will be lower in retirement, then a traditional IRA may be a good fit. No one knows the future, so the important thing is to get started contributing to an IRA if you haven’t started yet!