Putting the Gold in Your Golden Years – Your Individual Retirement Account
As the year winds down it’s good to think about the condition of your basket of retirement savings and investments. Let’s take a very simplified and superficial look at individual retirement accounts or IRAs.
If your employer does not offer a retirement program or if you are self employed, you can open your own IRA. You cannot be older than 70.5 years and make contributions to a regular IRA, however this limitation does not hold for Roth IRAs.
Think of your IRA as a basket or box. You can put cash savings into this container and financial instruments: stocks, bonds, mutual funds, among others, as long as they are approved or “qualified” by the IRS. You have to pay taxes on the money and other items in your IRA box – sooner or later.
With a regular IRA you pay your income tax later when you withdraw the money. With a Roth IRA, you pay your income tax now and withdraw the money later without tax since you have already paid the tax on it.
Traditional IRAs
In a traditional IRA your taxes are postponed or deferred until you start drawing money out of your IRA. Withdrawals may begin without a penalty when you are 59.5 years old. IRS approved or “qualified” Investments in a regular IRA are called qualified tax deferred investments. If you withdraw money or take income from other items in your IRA before you are 59.5 you will have to pay a penalty. Since the income taxes have not been paid on qualified investments in a regular IRA, it is called using pre-tax money. By having a regular IRA, you may be able to pay fewer taxes on the income since your income will probably be lower when you retire.
Roth IRAs
With a Roth IRA, you can put after-tax income – money and investments on which you have already paid taxes – into your Roth IRA now and receive the income later tax free. Investment of this type are made after you have paid income tax on them – after-tax income. The name of the Roth IRA comes from its sponsor in Congress, Senator William Roth of Delaware (1921-2003). Roth IRA’s can be helpful if you anticipate that your income will be high enough when you retire that paying more taxes late in life is not that desirable. The Roth IRA can work for you if you are concerned about not having enough income to pay the taxes and still have enough to live on.
Alternatives for the self-employed or business owners
If you are self-employed or a business owner there are two other types of IRAs specifically designed for your needs: SEP IRAs and Simple IRAs. (Alternatively you could also have a more traditional type of retirement plan such as a 401(k) plan.) Dates for establishing and funding these retirement plans may vary based on business structure (proprietorship, partnership, corporation, LLC) and tax filing deadlines.
Getting Started
This is, obviously, a very short and very oversimplified introduction to Individual Retirement Accounts. If you’re just getting started and don’t have a lot of savings or assets, you can open up an IRA at your local bank or credit union as long as you meet the IRS requirements. It is also a good idea to start reading about financial planning. The important thing is to get started. You have until April 15, 2013 to open and fund a regular IRA and defer taxes on your 2012 income, but be certain to tell the bank or credit union that the money is for your 2012 contribution.
How can you get extra money to put in a retirement savings account? There’s a good guide for financial planning for beginners from the Federal Reserve Bank of Dallas, Building Wealth: A Beginner’s Guide to Securing Your Financial Future. When you talk to people at your bank or credit union, don’t be afraid to ask “dumb” questions because when it comes to your money, there are no “dumb” questions.
Professionals know that retirement plans are complicated. Be sure to find and stick with a trusted professional advisor who speaks to you clearly as an equal. Many advisors make their living by selling insurance, annuities, mutual funds, stocks, or bonds. There are also financial planners who do not get paid by sales commissions. They charge a fee. When you talk to people or go to various websites, don’t be surprised if people want to sell you something to put into your IRA box.
Who is a good financial advisor? Stay tuned. We’ll take that up in later posts. Prepare for a Happy New Year and remember, the only money you really make, is the money you save.
Additional Resources:
All About IRAs – a very accessible explanation
