February 26, 2024

While saving for retirement can feel overwhelming, using an Individual Retirement Account (IRA) is a popular way to make the process easier and more efficient.

IRAs are flexible, tax-advantaged investment accounts that encourage you to invest more of your money for the future. Whether you’re just starting your career or have been implementing an employer-sponsored retirement plan for a while, an IRA can be a great vehicle for achieving your financial security and retirement goals.

What is an Individual Retirement Account?

An IRA is a long-term investment account that allows you to use your money for retirement while enjoying tax advantages. You have a variety of options for investing your IRA money, including stocks, bonds and mutual funds. IRAs are relatively easy to open and can often allow your money to grow faster than money in a taxable account.

What are the Different Types of IRAs?

There are two main types of IRAs: Traditional IRAs and Roth IRAs. The main difference between a traditional IRA and a Roth IRA is when you can take advantage of the tax benefits of the account.

Contributions to a Traditional IRA are generally tax-deductible, which means you can deduct the amount you contribute from your taxable income for the year. Investment growth within the account is tax-deferred—in other words, you don’t pay taxes on the income until you withdraw the money in retirement. These withdrawals are generally taxed as ordinary income.

This is beneficial for many seniors, who may be earning much less money in retirement than they did at work. As a result, they may pay a lower tax rate when they withdraw their superannuation than they paid tax before.

Contributions to a Roth IRA are made with after-tax funds, which means you don’t get an upfront tax deduction. Instead, the investment income you accumulate in the account, as well as qualified withdrawals, are tax-free. Unlike a traditional IRA, Roth IRA contributions have income limits. Roth IRAs are often beneficial to young adults who may pay higher tax rates in the future.

Both types of IRAs have contribution limit Established by the Internal Revenue Service (IRS) and may change over time. Through 2023, the combined annual contribution limit for Traditional and Roth IRAs is $6,500, with an additional $1,000 for individuals age 50 or older. This means that once you turn 50, you can start contributing $7,500 a year to your account.

Another thing to note: There’s something called a SEP-IRA, or Simplified Employee Pension Invested Retirement Account. It’s typically established for the self-employed (including business owners) to compensate for the lack of traditional 401(k) retirement savings options. You can learn more about SEP-IRAs here.

How to set up an IRA

Here’s how to get started:

  1. Decide which type of IRA account you want to open: Decide whether you want to open a Traditional IRA or a Roth IRA. Consider factors such as your income, tax situation and long-term financial goals. This decision will determine the tax treatment of your contributions and withdrawals, so don’t make the choice without careful consideration.
  2. Choose a Financial Institution: Research and choose a reputable financial institution that offers an IRA. This could be a bank, credit union, brokerage firm, or online investing platform. If you already have taxable brokerage accounts that you want to consolidate, consider factors such as fees, investment options, customer service and convenience, as well as the types of assets that can be transferred into the account.
  3. Gather required information: After selecting a financial institution, gather the necessary information and documents. These typically include your social security number, contact information, employment details, and a valid state-issued photo ID. Passports, driver’s licenses, and military IDs are usually acceptable options when you open an account.
  4. Complete the application: Complete the application form provided by your financial institution. You can usually do this online or by visiting your IRA provider’s local branch. Provide accurate information and read the terms and conditions carefully.
  5. Funding Your IRA: Once your application is approved, your IRA provider will open your account and help you fund it. Decide how much you want to contribute to your IRA. Make sure your contribution doesn’t exceed the annual limit set by the IRS, but also make sure it fits within your personal budget. You can make a one-time donation, or set up automatic recurring donations from your bank account.
  6. If you have a self-managed IRA in your brokerage account, determine how you want to invest the money in your IRA. Your account may offer various investment options such as stocks, bonds, mutual funds and exchange-traded funds (ETFs). When making your selection, consider your risk tolerance, time horizon and investment objectives.
  7. Monitor and manage your IRA: Regularly review your IRA performance, adjust your investments as needed, and track your contributions. You can check the price changes of your investments to see how their value has increased or decreased over time – typically you can view this information on your account statement or on your account’s online dashboard. Consider consulting a financial advisor to effectively manage your retirement savings.

The exact process you follow to open an account may vary depending on your provider.

IRA Pros and Cons

IRAs have both advantages and disadvantages that you need to consider before choosing where to invest your funds. Some benefits include:

  • Tax Benefits: One of the main benefits of an IRA is the potential tax benefits. With a traditional IRA, your contributions may be tax-free, reducing your taxable income for the year. In a Roth IRA, while contributions are made in after-tax dollars, qualifying withdrawals in retirement are tax-free. These tax benefits can help you save money and potentially grow your retirement funds faster than taxable accounts.
  • Retirement Savings Growth: Your IRA has the potential to appreciate in value and/or earn interest when you invest your contributions in financial instruments such as stocks, bonds, mutual funds or ETFs. What’s more, you’ll likely see a compounding effect of these gains over time.
  • Additional retirement savings: An IRA provides the opportunity to save additional money specifically for retirement, beyond the amount you may already be contributing to an employer-sponsored 401(k) plan. This can be especially beneficial if your employer has limited plan investment options.

However, IRAs have some disadvantages to be aware of:

  • Contribution Limits: The annual contribution limit to an IRA is set by the IRS. Through 2023, the limit is $6,500 per year. (Those over 50 can contribute up to $7,500 a year.)
  • Early withdrawal penalty: IRAs are designed for long-term retirement savings, and there may be penalties for withdrawing funds before age 59 1/2. Early withdrawals from a Traditional IRA are usually subject to income tax and a 10% penalty. You can withdraw Roth IRA contributions without penalty, but there may be a 10% penalty and tax on the income.
  • Required Minimum Distributions: Traditional IRAs require you to begin withdrawing a certain amount, called a required minimum distribution, from the account after you turn 73. These distributions are subject to income tax. An RMD can reduce the tax advantages of a traditional IRA and can force you to withdraw more than you need, potentially affecting your overall financial plan.

How is an IRA different from a 401(k)?

IRAs differ from 401(k)s in several ways.

An IRA is an individual retirement savings account that you can open independently. Like a 401(k) plan, it offers certain tax advantages and allows you to choose from a variety of investment options.

A 401(k), on the other hand, is an employer-sponsored retirement plan offered by companies to employees. It allows employees to contribute a portion of their wages towards retirement, usually before taxes and usually as employer-matched contributions. Generally, 401(k) plans have higher contribution limits than IRAs and may offer additional features such as loan reserves.

A 401(k) uses pre-tax income, which lowers your taxable income (and your income tax bill). Your 401(k) growth is also tax-free. Like a traditional IRA, your qualified withdrawals will be taxed, but at a lower rate because you’ll likely have lower income in retirement.

How Haven Life Can Help You Prepare For The Future

Opening an IRA is just one of the many ways you can plan and invest for your future. Another way to protect yourself is to purchase life insurance.

Haven Life term life insurance can give you and your family peace of mind when the unexpected happens to you. Start your free online quote today and find out how term life insurance can help you move towards a bright financial future.