What is an IRA and What are the different types?
An IRA or individual retirement account works towards saving money for your retirement without tax or at a deferred rate. However, which one is right for? Here are some IRAs you may want to consider:
- Traditional IRA: Contributions to traditional IRAs are tax-deductible and can grow without added tax until you withdraw money in retirement. Your withdrawals are taxed at your income rate during retirement. By deferring your tax-collection until after you reach retirement, you can be taxed at a lower rate.
- Roth IRA: Have extra cash left after tax? You can put aside these savings to grow tax-free and you can take out money tax-free during retirement. Make sure to research your financial institution’s requirements otherwise you may be penalized.
- SIMPLE IRA: Designed to allow small businesses to provide retirement plans for their employees, SIMPLE (Savings Incentive Match Plan for Employees) IRAs enable both the employee and employer to make contributions.
- SEP IRA: The difference between a SIMPLE IRA and a SEP (Simplified Employee Pension) IRA, is that only the employer or self-employed account owner can contribute to a SEP IRA.
Different rules also apply for different IRAs. For example, you can contribute a maximum of $6,000 to your traditional or Roth IRA. However, depending on circumstance, you can contribute up to $13,5000 in SIMPLE and SEP IRAs. In addition, extra savings can be contributed to these employer-driven accounts depending on your salary. Therefore, it is important to know what account best suits your saving needs.
Should I Open an IRA
- Understand your eligibility: The most accessible IRA is the Traditional IRA but depending on your individual circumstance, you may opt for an alternative which is more beneficial in the long run. For example, if you can qualify for a retirement plan through your employer, you can take advantage of traditional tax deductions and potentially extra contributions from your employer.
- Investing on autopilot: Depending on your interest and free time, you can take advantage of investing options once opening an IRA. Index funds or actively managed mutual funds are very low maintenance and less risk by spreading out your assets. If you are ready to gamble high risk for high rewards, you can use an IRA to invest in individual stocks.
- Budget for your untouchable savings: Most IRAs have penalties if you withdraw money before the full retirement age, which is usually 59 1/2 years of age. If you do not have a valid reason to justify your withdrawal, you may face a penalty of up to 10% depending on the IRA plan. Always assess whether you can afford to put regular savings aside and have enough accessible income to cover emergencies.
Other Ways to Save For Retirement
- Tax-deferred annuities: Annuities are offered through insurance companies and enable you to defer tax while offering a range of investment opportunities to add to your savings. However, like with any investment, performance is not guaranteed so be cautious with return on investments and who you trust your money with.
- Real estate investments: REITs (Real Estate Investment Trusts) are cost-effective and transparent. You may even be able to reduce your living expenses by living in a large property and renting out spare rooms and communal areas.
- Minimize Expenses: The less money you spend, the more you can put away for savings – for example, by saving money on monthly bills and utilities. If possible, switch to a more affordable energy providers or cancel unused subscriptions.
Although it is a lengthy process, always consider your options to ensure you have enough money for retirement. Make sure to monitor your investments and make adjustments to your plans as you near retirement and if your goals change.