If you’re young, you’re probably not thinking much about your retirement that may be decades away. If you’re more advanced in age, you may have put retirement planning off, since it can be confusing to figure out which is the best way to save. No matter which of these boats you’re in – or if you’re somewhere in the middle – now is the time to chart a course toward a happy and secure future and do it using IRAs. An Individual Retirement Account (IRA) is one of the most common retirement account types. IRAs function like a savings account and an investment account in one and are popular for several reasons:
Big Tax Benefits
The money and investments you hold in an IRA account grow tax-free. And depending on the type of IRA you choose (see more on these below), you’ll get even more tax breaks, either on the money you put into it each year (your annual contribution) or on the money you take out of it once you retire.
An IRA is not an investment itself. It is simply an account in which you can hold various types of investments (stocks, bonds, etc.) as well as cash and other assets.
With these rewards come a few catches. Different IRAs each come with their own eligibility requirements and restrictions as well as yearly contribution caps, and they all penalize you for taking money out of the accounts before you reach retirement age (with a few exceptions), meaning IRAs are only a smart place to put money that you know you don’t need to access right away.
There are several kinds of IRA accounts, but the two most common are the traditional IRA and the Roth IRA. Here’s how they differ.
- You get the tax break on the front end since annual contributions made to your IRA reduce the amount of income you have to pay taxes on each year.
- Almost anyone can open a traditional IRA.
- There are steep penalties for withdrawing money before retirement age.
- Once you hit 70.5 years of age, you must begin withdrawing money from your traditional IRA.
- You get the tax break on the back end, meaning you can withdraw the money at retirement and pay no taxes on it.
- There are some limits on who can open a Roth IRA, usually associated with level of income. People who make above a certain amount are not eligible for Roth IRAs.
- The penalties are less severe if you need to withdraw money early.
- You can leave money in your Roth IRA for as long as you want and allow it to continue to grow, tax-free.
Since you can put almost anything in your IRA (the IRS does have a few restrictions), you’ll have to decide what your IRA’s holdings will consist of. A good place to start is to find your risk tolerance by figuring out how much you’re willing to possibly lose for the chance at bigger gains and therefore, how conservatively or aggressively you want to invest. Risk tolerance is often determined by several factors:
- Your age
- Your investment objectives (in this case, a comfy retirement)
- Your net worth and other investments (aside from your IRA)
- Your personality (how you react to ups and downs in your account level)
Now that you know where you stand and what you’re comfortable with, you can begin making asset allocation choices – that is, picking what mix of stocks, bonds, annuities, other investments and cash you want in your IRA.
It’s always a good idea to have a diversity of assets in your IRA, but exactly what percentage of what depends a lot your specific situation. Consider these things:
- Your risk tolerance
- Your current age (so how long the assets will be in the IRA before you need them)
MAX’s friendly and knowledgeable investment advisors are happy to answer IRA questions and help you make asset allocation choices.