Before you stop reading this article because you feel retirement is still decades away, let’s be clear – you need to begin to save for your later years today. No matter if you are 25, 35, or 45, social security will not be the answer to your financial prayers. Statistics paint a grim picture of the current state of retirement readiness among most working Americans:
- 44 percent of American workers have yet to begin planning for (saving for) retirement
- 38 percent have less than $10,000 saved for retirement
- 20 percent of American workers believe they will never be able to retire.
Those numbers are scary, however you can take steps to ensure if you currently fall among one of those groups of people, this time next year you are working your way off those lists.
Let’s talk about what an IRA is. An individual retirement account simply put is an investment account that builds your retirement savings. There are a number of different types of IRA’s, including Roth, Traditional, SEP, and Simple. Each offers unique tax benefits that reward you for saving. You must have earned income in most cases to contribute to an IRA.
The most popular IRA’s are Roth and Traditional. The Internal Revenue Service (IRS) will allow you to contribute up to $6,000 per year ($7,000 if you are over 50). This is above and beyond the contributions you can elect to your company’s 401(k) or similar plan. Roth IRA’s offer contributions that are not tax deductible, meaning your investments grow tax free, and you can withdraw money tax free in retirement. Traditional IRA’s are tax deductible up to IRS limits, and you won’t owe income taxes until you withdraw the funds.
Your current financial institution likely has an investment or retirement offering of both of these products. Depending on who the provider is, your investments will certainly vary.
In most cases, high wage earners will not receive an immediate tax break on Roth or Traditional IRA’s, and we advise that you consult your local tax professional to see about your personal situation. If you decided you wanted to withdraw funds from your IRA prior to retirement, be prepared for some hefty penalties.
If you are younger than 59 ½, you will owe income taxes and an additional 10 percent penalty for withdrawals. There are some exceptions, which are listed below:
Roth IRA Early Withdrawal Exceptions:
- You are taking out no more than $10,000 for the purchase of your first home (we do not suggest doing this)
- The withdrawal is for qualified education expenses (we do not suggest doing this)
- The withdrawal is for unreimbursed medical expenses in excess of 10 percent of you adjusted gross income
- The withdrawal is due to disability
- The withdrawal is made out to a beneficiary or your estate after your passing.
- While unemployed, the withdrawal is to cover health insurance premiums.
- The withdrawal is due to an IRS levy/lien.
If you are older than 59 ½, and have had your Roth IRA for at least five years, you can withdraw earnings with no penalty or tax. If you have had the Roth IRA for less than five years, you will have to pay income tax, but will avoid any penalties.
In many cases, there are dire reasons you would potentially considering a withdrawal, however it is important to know the options available to you in the event circumstances arise that you have to consider it.
Special Case IRA’s
Aside from the popular Roth and Traditional IRA’s, there are other special case IRA’s offered based on your financial picture. One of the most popular option is a retirement strategy known as a “Backdoor IRA”. With a Backdoor IRA, you would open a traditional IRA, and then convert it over to a Roth. It is often suggested by experts for high wage earners to enjoy the benefits of a Roth although they be above the income limits of opening a conventional Roth IRA. If your adjusted gross income is above $137,000 (single) or $203,000 (married filing joint) consider speaking to a professional about establishing a backdoor Roth IRA.
Self employed individuals and Small Business Owners are able to open SEP IRA’s, which stand for simplified employee pension. Like a traditional IRA, the SEP offers a tax deduction on contributions. All of your savings will grow tax deferred, and withdrawals taken in retirement will be taxed at regular income tax rates.
For small business owners, the IRS will require you to contribute to your employees SEP IRA at the same rate you contribute to your own. SEP IRA’s are popular retirement vehicles for business owners because the maximum contribution is nearly ten time higher for a SEP ($56,000) than it is for a traditional IRA ($6,000). The IRS does limit the total percentage of your compensation you can contribute to 25 percent.
By this point you may be saying, who should I open my IRA account with? GoodMoneyAdvice has our very short list of our four best options you should consider.
Best Overall Platform
TD Ameritrade has a great interface, no account minimum, endless retirement tools and information at your fingertips, and great customer service. TD Ameritrade is not the lowest priced (see Merrill Edge, E Trade) however they do provide the most comprehensive client experience. If you are just starting out or an experienced investor, you will feel comfortable with TD Ameritrade.
Best Worry-Free Platform
SoFi Automated Investing has taken the crown from Bettermint as our choice for the best option for those who prefer a hands-off approach. SoFi does require $100 to stay in the account, however offers wonderful customer support, and a good variety of investment options for investors of all levels.
In case you were wondering how you stacked up against those in your age bracket, we saw this chart over at The Motley Fool recently, reflecting how much the average American has saved in their IRA.
As you can see, a couple numbers pop off this chart. Young professionals just entering the workforce (under 25), are adopting savings habits, and on average have more saved in their IRA than those in the late 20’s. You also see a jump once Americans enter their 40s, as they tend to get serious about saving for life after their career, and as their debt decreases, monies can be diverted to retirement.