No matter how far off your retirement date may be, there’s no time like the present to start planning for a financially secure future. One tool for helping you afford to live comfortably during your golden years is an individual retirement account, or IRA. Similar to a savings account, you can deposit money into and make investments with your IRA, where they remain until you’re ready to draw on the earnings to support you during retirement. If you’re looking to build savings for this phase of your life, learn more about how an IRA can suit your needs.
What’s an IRA?
An IRA is a type of account that’s almost like a bank account. It’s not an investment product like a bond or mutual fund, but you can add these and other types of investment products — along with cash — to it. The versatility and flexibility make IRAs a highly personalizable investment option, allowing you to diversify what you add into your portfolio or stick with options you’re familiar with. When you make contributions to your IRA by adding money or investment products, those contributions grow over time by earning returns or interest, which increase the value of your account.
Although traditional IRAs help your investments gain value over time, they do have certain limitations. For 2022, you can contribute a maximum of $6,000 if you’re younger than 50 or $7,000 if you’re over age 50, according to the Internal Revenue Service. Even if you have multiple IRAs, you’ll need to stick to the contribution limits — spread across all accounts, not for each — for a calendar year. If you’re familiar with IRAs, you may remember that it used to be the case that you weren’t allowed to continue making contributions after age 70½, however as of 2020 that restriction was lifted. One IRA, called a Roth IRA, specifies income limits. If you earn more than a certain amount of income in a calendar year, you may not be eligible to invest in this IRA type.
Types of IRAs
There are several types of IRAs, and each allows you to make contributions a little differently. These accounts also have distinct tax advantages. Compare the types to determine which one may best meet your needs:
Traditional IRAs allow you to make untaxed contributions to your account. This means that the contributions you make during a calendar year aren’t subjected to income taxes for that year. However, once you withdraw the money or liquidate an investment in your retirement, you need to pay taxes on the funds you withdraw. Roth IRAs are funded with after-tax income. You pay taxes on the contributions to the IRA for the year you add that money to the account. Then, the money in your IRA isn’t taxed as income at the time you withdraw it. SIMPLE IRAs are employer-provided plans wherein your employer matches whatever contributions you make, dollar for dollar. SEP IRAs let your employer make contributions to the account in your name as an alternative to a company pension. Self-employed people also often use these IRAs, which have lower setup costs.
Opening an IRA
Remember that IRA versatility? It also extends to the ways in which you can open one of these accounts. You can visit a local bank branch to start your IRA, or you can open an account online through a financial provider. Typically, the steps you take to open an account vary based on the provider you choose, but they’re often similar to opening a bank account. In most cases you’ll need to choose the type of IRA you want and provide personal information such as your name, date of birth, Social Security number and employment information. You’ll also have the option to choose the types of investments you want to make once you fund the IRA.
Funding Your IRA
Like depositing money into a bank account, funding your IRA is a relatively simple process — and you have several options. You can transfer funds directly from your bank account into the IRA or set up automatic deductions to periodically move money from your bank account into your IRA. If you switch jobs, you can also roll 401(k) money over to start an IRA. You can even add money from an existing IRA into a new one.
Once there are funds in your IRA, you can use them to purchase other investment products like stocks and bonds. You can also sometimes use your IRA to make charitable donations. Depending on the institution with which you’ve set up your account, a broker or other investment professional may be available to help you invest and reallocate IRA funds. This person can be an important point of contact for you as you learn the ropes of managing your account, so don’t be afraid to ask questions or have him or her guide you until you’re more comfortable making decisions. Once you become familiar with the IRA-investing process, you’ll be well on your way to securing a comfortable retirement.