Why You Should Especially Use an IRA for Retirement
When you think about retirement savings, 401(k)s typically take center stage. But if you’re not using an Individual Retirement Account (IRA), you might be missing a great opportunity to grow your wealth. If you’re self-employed, if you’re already putting money into a 401(k), or if you just want an extra boost to your retirement savings, an IRA can be a total game changer.
In this blog, we’ll cover the definition of an IRA, the various types, and how using one can help increase your retirement security.
What is an IRA?
An Individual Retirement Account (IRA) is a retirement account that allows you to invest and save for retirement while receiving tax benefits. An IRA is not an employer-sponsored plan like 401(k)s, but something you take responsibility to set up and manage. It can give you more control over your investments by allowing you to invest in stocks, bonds, mutual funds, and other assets, including exchange-traded funds.
A few of the popular types of IRAs are: Traditional IRAs and Roth IRAs. Each offer unique advantages and tax implications, so selecting the one that’s right for you depends on your financial situation and retirement goals.
Traditional IRA vs Roth IRA: Which is right for you?
Both types of IRAs offer significant tax benefits, but in different ways:
Traditional IRA:
Contributions are tax-deductible, lowering your taxable income today.
Withdrawals in retirement are taxed at ordinary income tax rates.
Required Minimum Distributions, or RMDs, start at age 73, so you have to withdraw money even if you don’t need it.
Roth IRA:
Contributions are in after-tax money, so you don’t get a tax break today.
You pay no taxes on withdrawals in retirement, as long as you’ve owned the account for at least five years and are over 59½.
There are no RMDs — you can let your money grow forever.
Which One Should You Choose?
If you expect to find yourself in a higher tax bracket in retirement, a Roth IRA is the better option because you’re paying taxes now at a lower rate, avoiding them later.
If you expect to be in a lower tax bracket during retirement, a Traditional IRA lets you defer taxes now, and you simply pay them (plus any investment growth) when you withdraw money.
If you’re self-employed or don’t have access to a 401(k), a Traditional IRA helps reduce your taxable income as you save for retirement.
How Much Can You Put in an IRA?
The individual contribution limits for IRAs for 2024 are:
$7,000 annually if you’re under 50.
$8,000 a year if you’re 50 and older (thanks to the “catch-up” contribution rule).
These limits are per person, not per account, so you can have multiple IRAs but can’t exceed the overall annual limit.
Roth IRAs come with income limits, however, so higher earners may not qualify to contribute directly. But there’s a little loophole called the Backdoor Roth IRA that lets you put money in a Traditional IRA and then convert it to a Roth ira.
The Ultimate Strategies For Investing Your IRA
This is the first step in saving money in an IRA. The way you invest it decides how much it grows in time. Here are some clever investment tactics:
Diversify Your Portfolio
NeverB putting all your eggs in one basket. Having a portfolio of stocks, bonds, real estate, and ETFs can help to minimize potential risk while also maximizing returns.
Choose Low-Cost Index Funds
Index funds and ETFs are typically cheaper than actively managed mutual funds. In the long run, those lower fees can save you thousands of dollars.
Adjust Risk Based on Age
If you’re young, focus on growth assets such as stocks.
As you near retirement, move into more stable assets, such as bonds and dividend-paying stocks.
Rebalance Annually
Market changes can cause your portfolio to get out of balance. Review annually and rebalance your investments, if required.
IRA vs. 401(k): Can You Have Both?
Yes! In fact, stacking an IRA on top of a 401(k) is one of the best ways to max out your retirement contributions. Here’s why:
Tax Diversification:
Traditional 401(k) + Roth IRA = pre-tax retirement income + tax-free retirement income.
It gives you control over your taxable income in retirement and tax liability.
More Investment Options:
401(k) plans often offer limited investment options, whereas IRAs allow you to invest in just about anything.
Higher Savings Potential:
You are able to max out both a 401(k) and an IRA, turbocharging the savings for your retirement.
Compound Growth Rule in an IRA
The more time your money has to stay invested, the more compound interest can accumulate. Let’s look at an example:
$6,000 a year in a Roth IRA from age 25 with an average 7% annual growth rate will grow to over $1.3 million by age 65.
If you wait until you’re 35 to start, you’ll have only $615,000.
That’s a $700,000 difference all because they started 10 years earlier!
Common IRA Mistakes to Avoid
Although IRAs are fantastic vehicles for retirement, there are a few common traps to avoid:
Not Contributing Enough Even small contributions compound over time. You should max out your IRA as often as you can.
Pretending Fees Don’t Exist — And high-cost mutual funds can eat up your returns. There’s no need to go elsewhere or find a replacement, just stick with a low-cost index fund.
Withdrawing Too Early — Removing money before age 59½ means paying taxes and penalties.
Forgetting Required Minimum Distributions (RMDs) — Traditional IRAs mandate that you begin taking distributions at the age of 73. Not doing so can result in a steep fine.
Not Naming a Beneficiary — Make sure you name someone to inherit your I.R.A.
IRA: A Must-Have for Retirement: Final Thoughts
A funded IRA can turn the retirement from surviving to living. The most important thing when considering a Traditional vs Roth IRA is to get started early and be consistent.
Those with a 401(k) should consider an IRA to diversify tax advantages and expand investment options.
If you don’t have a workplace retirement plan, an IRA is an absolute must to have a secure financial future.
Retirement planning is not a matter of luck — it’s a strategy and a discipline. If you’ve never opened an IRA, then this is the time to do so. Your future self will appreciate it.