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What is an IRA?

I’m sure by now you have heard of an IRA. But do you really know what it is?

…OK, not the Irish Republican Army. Not that IRA.

IRA actually stands for Individual Retirement Arrangement, not the more commonly referred to Individual Retirement Account.

An IRA is not a specific account, it is merely how the IRS views an account. An IRA can be opened at many online brokerage firms such as Scottrade, TD Ameritrade, Etrade, Sharebuilder, Betterment.com, Fidelity and any brick and mortar brokerage.

You can also open one at your local bank, but unless they have a wealth management department you will likely be investing in CD’s that are labeled as an IRA.

IRA

There are a few different types of IRAs. Which one is right for you depends on your individual situation.

  • Traditional IRA
  • Roth IRA
  • SEP IRA – Simplified Employee Pension
  • SIMPLE IRA

Although there are various types of IRAs, many of the characteristics are the same.

Traditional IRA

  • Contributions may be tax deductible.
    • You may be able to deduct up to $5,500 ($6,500 if over 50 years of age) in 2013. Rollover contributions are not included in this limit.
    • This is the best option if you will be in a lower tax bracket in retirement, but nobody knows what taxes will look like when they retire.
  • The deduction may be limited if you or your spouse are covered by a retirement plan at work or if your income exceeds certain levels.
  • Contributions cannot be made after you reach age 70 1/2.
  • Distributions prior to age 59 1/2 will have a 10% penalty tax assessed in addition to regular income tax. (removing excess contributions are not subject to the penalty)
  • The plan requires minimum distributions beginning April 1st of the year following reaching age 70 1/2.

Roth IRA

  • Roth IRA contributions are not tax deductible.
    • Roth contribution limits for 2020.
    • Although they aren’t deductible the income during retirement is tax free, since you have already paid the taxes before you contribute.
  • If you meet the requirements, qualified distributions are tax free.
  • You can contribute even after you reach age 70 1/2.
  • Great for those who continue to work.
  • You can leave money in your Roth IRA as long as you live, no required distributions.
  • Contributions can be made even if you are contributing to a retirement plan through work.
  • Contributions can be withdrawn without penalty or taxes. This does not include any earnings made.

SEP IRA

  • This is a simplified method of contributing to a retirement plan for business owners and their employees.
  • This is treated as and follows the same guidelines as a Traditional IRA.

SIMPLE IRA

  • This is a simplified method for small employers and their employees to make salary reduction contributions.
  • This too is treated as and follows the same guidelines as a Traditional IRA.

Regardless of what you choose the decision to save for retirement is extremely important. Many people are dependent on social security to provide the income they need during their retirement years. Unfortunately for them it wasn’t until they actually retired that they discovered it was a bad decision. Social security is a supplement to your retirement. It does not and will not provide enough income for you to maintain your standard of living once retired.

Becoming debt free is just as important as saving for retirement. Who wants to be retired only to have to send your retirement income to the bank? By owning your house and only having to pay the real estate taxes and the insurance premiums you will effectively increase your income in retirement and decrease the need for additional cash.

Social Security is not designed to provide for all of your retirement needs. It is imperative that you begin saving for retirement as the value of the Social Security Program will decline year after year. For more information you can always check out the IRS IRA page.

I prefer to manage my investments myself because I have a very difficult time putting my family’s future in the hands of a salesmen. That is what most financial advisors are, salesman. There are a few good, honest advisors out there but if they work for a brokerage firm they are required to meet certain sales goals even if it isn’t in the best interest of the client (you).