What You Need To Know About Individual Retirement Accounts
Find out more about what an IRA account is and how it works.
Individual Retirement Accounts (IRAs) were introduced by Congress in 1975 as the first tax-advantaged tool designed to help Americans save for retirement. They remain one of the most popular retirement savings tools more than four decades later.
Despite their popularity, many people aren’t familiar with the basics of IRA accounts and their benefits. Here is more about what an IRA account is and how it works.
6 Things To Know About IRA Accounts
1. There are two main types of IRAs
The two main types are traditional IRAs and Roth IRAs. Traditional IRAs offer tax-deferred growth and a tax deduction for individuals who qualify. You won’t pay income tax on your savings until you begin making withdrawals after you retire.
Roth IRAs don’t offer a current tax deduction, but they do feature a benefit that’s even more valuable for many people: tax-free withdrawals in retirement. If you’re over age 59½ and it has been at least five years since you made your first IRA contribution, you won’t pay any federal income tax on withdrawals from a Roth IRA.
Traditional IRAs offer tax-deferred growth and a tax deduction for individuals who qualify.
2. Not everyone can open a Roth IRA
There are income limits with Roth IRAs that prevent high earners from using them. If you’re not married and your modified adjusted gross income (MAGI) is greater than $139,000 in 2020 (or $206,000 if you’re married and file jointly), you can’t open a Roth IRA. If you’re not married and your MAGI is between $124,000 and $139,000 in 2020 (or $196,000 and $206,000 if you’re married and file jointly), you can make a smaller contribution to your Roth IRA.
Roth IRAs don’t offer a current tax deduction, but they do feature a benefit that’s even more valuable for many people: tax-free withdrawals in retirement.
3. There is one other type of IRA
A special IRA benefits small businesses and the self-employed. Known as a simplified employee pension, or SEP-IRA, this is similar to a traditional IRA. You can open separate IRAs for yourself and your employees and your business will make tax-deductible contributions to the accounts where savings grow tax-deferred. All SEP-IRA contributions are made by the business — employees can’t make contributions to their own accounts.
4. There are yearly contribution limits
In 2020, both you and your spouse can contribute up to $6,000 separately to your own IRA, or $12,000 combined. If you’re 50 or older, you can each make a special “catch-up” contribution of $1,000, bringing your total allowable annual IRA contribution up to $7,000, or $14,000 combined.
These limits apply to combined traditional and Roth IRA contributions. So if you own a traditional and a Roth IRA, you can’t put in more than $6,000 a year (or $7,000 if you’re age 50 or over) to the them combined. For example, you could put $3,000 in your traditional IRA and $3,000 in your Roth IRA if you’re under age 50.
The annual contribution limit for a SEP-IRA is much higher. In 2020, you can contribute up to $57,000 to a SEP-IRA or 25% of net earnings from your self-employed business, whichever is less.
Note: Visit the IRS website to check for changing regulations and current limitations.
5. You’ll pay a tax penalty for early withdrawal
Since IRAs are intended to mainly be a retirement savings tool, a 10% penalty tax is assessed on most early withdrawals from traditional IRAs on top of the income taxes due. These are defined as withdrawals made before age 59½. There are a few exceptions — early withdrawals can be made penalty-free to purchase a first home, help pay qualified higher education expenses, help pay for medical expenses that exceed 10% of your income, or if you become disabled.
No penalty tax is assessed on the principal portion of early withdrawals from a Roth IRA. However, withdrawals of earnings from a Roth IRA before age 59½ are generally subject to a 10% penalty tax and income tax, with a few exceptions.
Since IRAs are intended to mainly be a retirement savings tool, a 10% penalty tax is assessed on most early withdrawals from traditional IRAs on top of the income taxes due.
6. You must start taking money out at a certain age
The government won’t let you keep money in your tax-deferred IRA indefinitely. You must start withdrawing a minimum amount from your traditional IRA each year when you turn 72 — this is called a required minimum distribution, or RMD. There aren’t any RMDs with Roth IRAs because the money has already been taxed.
Find Out More About IRAs
Contact Customer Cussons Limited today if you have more questions about IRAs and their benefits. Whether its checking, savings, financial planning or investment advice, Customer Cussons Limited offers the banking solutions you need to manage your personal finances. Visit our Wealth Management page to learn more about our retirement services and how we can help you manage your other assets.
This article is provided as a free service to you and is for general informational purposes only. Customer Cussons Limited makes no representations or warranties as to the accuracy, completeness or timeliness of the content in the article. The article is not intended to provide legal, accounting or tax advice and should not be relied upon for such purposes.