How to Choose a Suitable IRA Account
- Saving for retirement is essential for living a comfortable life after working for many years.
- Depending on the line of work, different types of Individual Retirement Accounts (IRAs) are available to help a person maximize their retirement savings.
Every week, bi-weekly, or monthly, one gets paid, and it is imperative that with every paycheck, a portion is put aside for retirement. Furthermore, it is crucial to put the earned income in a tax-advantaged account, because typically when a person retires, they will not have consistent income. Instead, they will need to rely on the retirement plans made when they were working.
Typically, a person puts aside the money for retirement into an IRA account. An Individual Retirement Account (IRA) is a type of account used for retirement savings. There are several different types of IRA accounts, and each of them has various advantages.
You may have heard of an IRA at your job or from being offered one within a certain financial institution. When people start a new job, they will often begin to put a small amount of money aside each paycheck to go toward their IRA.
An IRA allows you to make contributions to the account whenever you wish, and the money can then be used for different investment choices, such as stocks, ETFs, and mutual funds. However, if withdrawals are made before the age of 59 ½, the withdrawal amount will be subject to a 10% withdrawal fee.
Different Types of IRAs
IRA accounts are not one-size-fits-all, although various IRA accounts provide unique tax benefits listed below to help determine the ideal account depending on one’s job.
A Traditional IRA is the most common type of IRA that is opened. The traditional IRA contribution limit was $6,000 in 2021, which will be deducted from one’s total taxable income. Furthermore, when the account holder reaches the age of 50, their contribution limit rises to $7,000.
Once the individual retires, the money withdrawn will be taxed at their regular income rate. However, it is essential to keep in mind that the annual contributions change each year. Therefore, make sure to check for updates as going over the contributions constantly could have repercussions.
A Roth IRA’s contributions are not tax-deductible as the money deposited into the account are after-tax dollars. Therefore, to make this type of account appealing to people wanting to save for their retirement, any profits made on investments or withdrawn money are tax-free. Because this type of IRA does not get taxed, it benefits people who want to invest their money consistently.
Image Credit: Shutterstock.com
SEP stands for “Simplified Employee Pension,” and independent contractors and small business owners use this type of IRA account. This account has the same withdrawal rules as the traditional IRA account. However, the difference is that the contribution limit is the lesser of either 25% of their income or $58,000.
Savings Incentive Match Plan for Employees (SIMPLE) is an IRA account that follows the same tax withdrawal rules as a traditional IRA account. The key difference is the employer must match the contribution amount made by the employee.
This type of account is for people who wish to get taxed at a lower rate as their contributions are deducted from their total income of that year, giving them the possibility to receive a higher tax return if they meet the threshold.
Difference Between an IRA account and a Savings Account
Although an IRA account and a savings account may seem similar at first, some key distinctions separate them.
When wishing to withdraw money from a savings account, it is recommended to transfer it into a checking account before withdrawing to avoid paying fees. However, if one wishes to withdraw from a savings account, there are withdrawal fees up to $15, depending on the financial institution.
If money is withdrawn from an IRA account before the withdrawal age of 59 ½, the withdrawn amount is subject to a fee of 10% of the withdrawal amount. Thus, if $1000 is withdrawn from an IRA account, one must pay a $100 fee for withdrawing before the agreed-upon time.
There are no restrictions on how much money can be added to a regular savings account, but the process differs from IRA accounts. Contributions to an IRA account cannot exceed $6,000, or taxes will be imposed on the excess amount. Furthermore, you will be charged a 6% tax for every dollar over the yearly limit which remains in the account.
To open an IRA account, you have to make sure the institution you set up the account with has been approved by the Internal Revenue Service (IRS) to offer these accounts. Some of the approved institutions include banks, brokerage companies, and federally insured credit unions.
Benefits of Saving Money in an IRA Account
When saving money for retirement, there are many benefits of putting the money into an IRA account instead of a regular savings account.
Unlike a regular savings account, an IRA account allows the account holder to invest their money. A savings account does not provide this privilege, and it makes all the difference. On average, a savings account’s interest rate is 0.06%. With the historical average inflation rate at 3.24%, the idle remaining in a savings account loses value each year.
That is not to say that a savings account is not essential, as it is essential to have an emergency fund if something unexpected happens.
However, when thinking about retirement, investing is essential to having enough money to enjoy life. On average, a Roth IRA account provides a seven to ten percent annual return on investments. Therefore, as investing is crucial, choosing a Roth IRA over a savings account is better when saving for retirement.
Photo Credit: Shutterstock.com
Employer Matches Contributions
Unlike a savings account, a SIMPLE IRA account allows the employer to match its employee's contributions, essentially doubling the amount of money being saved each time.
As the old saying goes, “Time is money,” and the sooner you start saving for retirement, the more money that can be accumulated when the time comes to hang up the boots. Furthermore, having an investment account is another great way to grow money until retirement, as compound interest allows it to grow steadily.
Which type of IRA would you prefer to take advantage of and why? Let us know in the comments below.
Main Image Credit: Shutterstock.com