An Individual Retirement Account (IRA) allows you to invest in stocks, bonds and mutual funds with tax advantages in mind. While it’s best to wait until retirement age to access this money in your IRA account, early withdrawal will incur a 10% penalty in addition to regular income tax liabilities.
Contributions are tax-deductible
If you want to save for retirement, a traditional IRA is an effective tool. Your contributions are tax-deductible in the year they’re made; withdrawals will be taxed at your income tax rate when taken, most likely at retirement time.
If your employer doesn’t offer a retirement plan or you are self-employed, an IRA is an ideal way to save for retirement. Choose between investing on your own through an online broker or hands-off investing via robo-advisor – these automated services make decisions tailored to meet your specific goals and investing timeline for much less than traditional managers would charge.
Traditional IRA contributions may have certain limits depending on your modified adjusted gross income and workplace retirement plan coverage. Withdrawals made before age 59 1/2 will incur federal income taxes as well as an early withdrawal penalty of 10%.
You can make penalty-free withdrawals at any time
Traditional IRA owners can withdraw their funds at any time, without incurring a penalty, provided they’re over age 59 1/2 and meet certain requirements. Any contributions or earnings taken out before this age must pay ordinary income tax as regular income taxes would apply to these withdrawals.
One exception to this rule occurs when funds are used to cover qualified higher education expenses for themselves, their spouse, children or grandchildren, or due to an IRS levy.
IRAs typically invest in mutual funds and stocks that fluctuate in value, exposing them to market risks like any other investment account. Furthermore, many mutual funds and equities require minimum investments – it’s best to find providers with low or no account minimums when looking for providers with an IRA account. Furthermore, taking withdrawals before age 59 1/2 could incur a 10% penalty fee.
You’re required to withdraw a minimum amount at age 59 1/2
If you are over 70 and withdraw money from a Traditional IRA, the government requires that at least an MRD be taken every year – this amount is known as your Minimum Required Distribution or MRD and calculated by dividing your previous year-end balance by either your life expectancy factor as indicated on either of two tables: Uniform Lifetime Table or Spousal Exception Joint Life Expectancy Table. Depending on your circumstances, taxes and an early withdrawal penalty of 10% could apply; depending on which table they fall under they could also not apply.
Longer you leave your IRA investments alone, the greater their tax-deferred compounding potential will become. But taking large distributions too soon could deplete your nest egg before retirement and cost a significant sum of money. To prevent this happening too early and depleting it too soon before retiring, start “substantially equal periodic payments” prior to turning 59 1/2 with your custodian; your money will then be distributed according to a prearranged schedule each year.
You can roll over a 401(k)
If you are changing jobs, transferring your old 401(k) into an individual retirement account (IRA) could be beneficial. With an IRA you have access to more investments at lower fees while investing more than what your old employer allows in their plan.
Rollover refers to the process of moving retirement funds between plans, or between providers, without incurring taxes and penalties. Although straightforward, there are certain guidelines you should abide by when undertaking such an undertaking – for instance, within 60 days to avoid taxes and penalties on any transactions made in between plans.
Once your money is in an IRA, it is your responsibility to select and manage its investments. For ease of use and low account fees, use an online broker or robo-advisor with low account fees that offers low cost investments; but keep in mind that all IRAs are exposed to market risks just like other accounts.
