Planning for retirement is now largely a do-it-yourself project, especially for the many people who are self-employed, work as independent contractors in the “gig economy,” or are employees of small businesses. Without access to a pension or even an employer-sponsored 401(k) plan, millions of working people rely on individual retirement accounts to supplement Social Security.
Fortunately, IRAs have significant tax advantages, as well as flexibility to adapt them to your particular needs. So it’s worth your while to understand what an IRA can do for you.
First thing to understand is that, whether you’re covered by another retirement plan or not, you can still open an IRA. You may want to put away more for retirement than your employer’s pension promises, or want more investment options than an employer-sponsored 401(k) plan offers. Most commonly, though, the IRA is the main retirement vehicle for entrepreneurs and people who work for small companies.
For those who, whether voluntarily or not, leave their jobs, an IRA is the best place to safely “roll over” the money in the employer’s plan and thus avoid negative tax consequences.
A “traditional” IRA allows you to defer taxes on the money you invest. Unless you exceed an income cap of $65,000 a year (or $104,000 for a couple) with an employer retirement plan, income taxes are due on those dollars only when you begin to withdraw funds. If you don’t have a sponsored plan available to you, you can then contribute to a traditional IRA to the maximum amount. There is a partial deduction allowed for income levels between $65,000 to $75,000 for individuals and between $104,000 to $124,000 for a couple. In 2021, there will be a slight adjustment increase in these levels. And, in theory, most people will be in a lower tax bracket by then.
But there are also advantages to paying tax on your retirement money up front, so your eventual withdrawals are tax-free. That’s where a Roth IRA comes in. (The name comes from the U.S. senator who sponsored the legislation that created this option.) Roth contributions are “post-tax,” meaning you have already paid income tax on the money you invest.
Why is this beneficial? Sometimes, for example, a person may experience a reduction in income, and fall into a lower tax bracket. Once a person qualifies for a lower tax bracket, Roth contributions would be advantageous by paying a lower tax rate now than the anticipated taxes when it's time to retire. A similar scenario involves experiencing a financial loss, such as a drop in the value of taxable investments. That loss can offset current income, thus reducing current income tax liability. Which might also mean it’s a good time to contribute to a Roth IRA.
Whichever type of IRA you own — and you can have both — you’re limited to a maximum contribution of $6,000 a year. There is one loophole. People over 50 years old can put in an extra $1,000 “catch-up” contribution. Effective this year, you can continue to contribute to a traditional IRA at any age, as long as you have earned income. The rules are a little trickier for a Roth IRA, so it’s a good idea to get expert advice on that subject.
With a traditional IRA, you’ll be required to start taking out a minimum amount (“required minimum distribution”) at age 72. That’s not required with a Roth IRA. One other advantage of a Roth IRA is that its principal passes tax-free to your heirs.
Either type of IRA allows you to begin penalty free withdrawals when you reach age 59½, or if you become disabled, or if you are buying a home for the first time.
With both types, you’ll have a wide range of choices about how to invest your money. Essentially most investment and money management firms offer IRAs. They present IRA investors with numerous investment options, including mutual funds and individual asset selections. Those cover the gamut from low-risk, low-return to highly speculative; various combinations of stocks and bonds; and a variety of managed and index funds. This isn’t the place to address how you should weigh your income needs versus your tolerance for risk; suffice it to say that’s a subject that any investor should discuss with a knowledgeable advisor.
Some experts say you should plan on retirement funds from all sources, including Social Security, to provide you with 85 percent of your pre-retirement income. That’s a guideline not a hard-and-fast rule. Some people may downsize their homes or move to a less expensive area, which would reduce their income requirements. Others may have plans for extensive travel, which might require a higher income. Once again, your own circumstances and needs should dictate your strategy, ideally with guidance from an experienced advisor.
Like other so-called “qualified” retirement plans, notably employer-sponsored 401(k)s, IRAs come with both tax liabilities and penalties if you make “unqualified” withdrawals. That is, if you either haven’t reached the minimum age or met one of the other criteria for taking out money. Those additional criterial include major medical expenses and college expenses for yourself, your children, or grandchildren.
Unlike a 401(k) plan, there’s no option to borrow from your IRA. There is a tricky option, if you truly have to get money out before retirement age, that locks you in to an IRS-determined amount of withdrawals that must continue, unchanged, until you’re 59 ½ years old. Not something to consider lightly, this is something that really requires good advice.
In most circumstances, however, some combination of traditional and Roth IRA is a good deal, a proven way to help ensure yourself a comfortable retirement and to minimize your taxes.
To help you understand how the various options fit with your overall investment and retirement strategy, we recommend consulting with Old North State Trust’s retirement experts. They can help you make the best decisions about how to set aside money for your future needs, and make your IRA truly “individual” for your particular circumstances.
As Marketing Director, Alyce works to develop, budget, and implement marketing plans, which include advertising, coordination of conferences, special events, and development and maintenance of marketing materials. She also oversees the company’s website, in-house articles, and fostering community initiatives within the organization. Alyce received a BS degree in Interior Design from East Carolina University with a concentration in Business Administration and obtained her teaching certification from UNCW. Old North State Trust professionals have many years of experience and for over a decade have assisted clients in identifying and reaching their financial goals. For more information, visit www.oldnorthstatetrust.com or call 910-399-5470.
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