No matter your stage of life, it’s never too early to start planning for your retirement. This includes opening retirement savings and investment accounts. Saving for retirement can feel overwhelming if you don’t know where to begin. A financial and investment expert can help you sort through the savings and investment options available.
Among your options are traditional IRAs and Roth IRAs. These savings accounts offer different benefits and limitations for investors. Learn the difference, what you need to open your account, and how to start saving for your retirement using an IRA.
Differences Between a Roth IRA and a Traditional IRA
Roth IRAs and traditional IRAs are two types of individual retirement accounts (IRAs). An IRA is a savings account that is opened to save and invest money for the long-term and is designed to encourage saving for retirement.
Anyone with earned income can open an IRA account through a bank, personal broker, online brokerage account, or an investment company. They offer tax advantages and allow you to invest in a wide range of financial products such as stocks, ETFs, bonds, and mutual funds. IRAs are a popular choice for retirement funds.
Traditional IRAs
A traditional IRA lets you use pre-tax income toward investments that grow tax-deferred. The IRS won’t assess any dividends or capital gains taxes on your traditional IRA account income until you or your beneficiary make a withdrawal. Any money withdrawn from a traditional IRA account is subject to income taxes and is taxable at your ordinary income tax rate.
Contributions to a traditional IRA account may be eligible for tax deductions. Tax deductions can be limited depending on if you or your spouse has a retirement plan at work or if your income exceeds a certain level.
Roth IRAs
Roth IRAs are similar to traditional IRAs but with significant differences in taxation. Contributions to Roth IRAs are made with after-tax money, but the money you put in and earn from your Roth IRA account isn’t taxed upon its withdrawal. You won’t face capital gains taxes, and the money is not subject to income tax. Roth IRA contributions can be made regardless of your age and are not tax-deductible.
You can withdraw money from a Roth IRA or traditional IRA at any time. If you are under the age of 59½, you may be subject to an early withdrawal tax of 10% if you don’t qualify for an exception.
Which IRA Am I Eligible For?
Just about anyone can contribute to an IRA account, no matter if it’s a Roth IRA or a traditional IRA. Before 2020, people aged 70½ or older were ineligible for traditional IRAs, but that is no longer the case. People of all ages are now eligible to contribute to any type of IRA.
The only current eligibility requirement is that you have an earned income. You may choose to open a Roth IRA if you prefer tax-free income during your retirement. You might prefer a traditional IRA for the tax benefits it offers.
Earned income is any income you receive from a job or self-employment and includes your salary or wage, tips, bonuses, and commissions you earn. Income that comes from investments or government benefits is not considered earned income and can’t be used to open an IRA account.
Roth IRA accounts do have income limits. Single people making more than $140,000 and married couples earning more than $208,000 can’t contribute to Roth IRAs. You may want to choose a traditional IRA if your income level makes you ineligible for a Roth IRA.
How Much Money is Needed to Start an IRA?
Traditional IRA and Roth IRA accounts don’t have minimum contribution limits set by the IRS, but some brokerage firms require minimum contributions to start. Do your research and compare minimum requirements if you’re looking to begin a traditional or Roth IRA with a brokerage firm.
While there aren’t minimums in place, the IRS places contribution limits for each tax year. Since 2020, you can contribute up to $6,000 total per year to an IRA account if you’re under the age of 50. People over the age of 50 can contribute $7,000 total per tax year. This means a person under 50 can contribute up to $500 per month to their traditional or Roth IRA.
How to Start Investing in Your IRA
Once you’ve decided to start an IRA, there are a few steps you’ll need to take before you start investing.
Compare financial firms and companies that offer IRAs
Many banks, financial institutions, and brokerage firms provide Roth IRAs and traditional IRAs. Once you’ve chosen which type of IRA you’d like to start, shop around and compare what companies offer.
Know if you’re looking for help managing your IRA or if you’d prefer working with a company that lets you take charge. You also need to know what type of investments you want to make with your IRA. Some companies may specialize in specific investment areas, while others focus on diverse portfolios.
You also need to know how much you’re looking to contribute immediately. Some companies require minimum amounts to start your savings account. You want to be sure you have enough funds saved if you have to meet a minimum requirement. Fees and commissions can also reduce early earnings if your initial contributions are small.
Fund your account and set up an investment strategy
Once your account is set up through your initial funding, you must determine how much you want to contribute to your IRA. You’ll also need to set up an investment strategy and choose your Roth or traditional IRA investments.
If your place of work doesn’t offer a retirement plan, you may be eligible for tax deductions if you have a traditional IRA. If this is the case, consider an investment strategy of contributing as much as you can toward the max limit each month. This will help you take full advantage of tax benefits and help quickly build your retirement funds.
Choosing a Roth IRA means you won’t get any tax advantages now but will enjoy the benefit of not paying income taxes once you reach retirement age and receive distributions from your account. They’re a good option if you believe your marginal taxes will be higher than they are currently are upon your retirement.
No matter which type of IRA you choose, consider investing as much as you can each month without negatively affecting your other financial goals. Decide which types of financial products you’d like to invest in based on your risk tolerance and investment portfolio needs.
Get Financial Advice for Your Retirement
Starting to save for your retirement doesn’t have to be complicated if you work with the right financial advisor. Like those at Finance is us, financial advisors and financial planners are trained to help you plan for your retirement.
We work with clients of all ages and backgrounds. Our advisors help you learn which retirement savings account is correct for you and offer strategies to maximize your earning potential. Contact us today to learn more about your IRA and other retirement savings accounts.
Disclaimer: All content on this site is information of a general nature and does not address the circumstances of any particular entity or individual, nor is the information a substitute for professional financial advice and services.
