My husband recently started a new job and I was surprised to learn that the company does not offer a 401(k) plan. This was the first time either of us had ever worked for a company that didn’t offer some sort of retirement benefit. After some research, I discovered that we were not alone. According to a 2022 AARP study, nearly half (48%) of Americans in the private sector don’t have access to employer-sponsored retirement plans like 401(k)s. This revelation prompted me to write this article to discuss the Individual Retirement Account (IRA) and how you can use it as part of your retirement saving strategy.
What is an IRA?
An IRA is a tax-deferred investment account specifically designed for retirement savings. The Internal Revenue Service (IRS) outlines six types of IRAs, four of which are offered by employers. However, for the sake of this article, we will focus on Traditional and Roth IRAs. These IRAs are beneficial for those who are self-employed or do not have access to employer-sponsored plans.
The Traditional IRA:
Similar to a 401(k), contributions to a Traditional IRA are tax-deductible. When you file your taxes, you report the amounts you contributed to an IRA. This will result in a reduction in your taxable income, assuming your income is below the IRS phase-out limits. Additionally, the money you contribute to an IRA grows tax-deferred. This means that you don’t pay taxes on any gains until you withdraw it in retirement.
There are a few key differences between an IRA and a 401(k) plan:
- IRAs have greater investment flexibility: Your employer will generally limit the types of investments you can choose for your 401(k) plan. However, depending on the broker or bank you choose for your IRA, you will have a much larger choice when it comes to IRA investments.
- IRAs lack employer-matching contributions and have lower contribution limits. The IRS limits the amount that you can contribute to retirement accounts. For 2024, the IRA limit is $7,000 per year ($8,000 for those 50 or older). On the other hand, an individual can contribute up to $23,000 to their 401(k) plan, in addition to the amount contributed by their employer.
The Roth IRA:
Unlike Traditional IRAs, contributions to a Roth IRA are not tax-deductible. However, they do offer tax-free growth and tax-free withdrawals in retirement, provided you meet the following criteria:
- Reach age 59 ½
- Five-year holding period (the time between your first contribution and withdrawal)
Withdrawal rules: Similar to Traditional IRAs, you can access your contributions at any time without penalty or tax. However, earnings withdrawn before age 59 ½ and without meeting the five-year holding period are subject to a 10% penalty and income tax. Unlike Traditional IRAs, Roth IRAs have no Required Minimum Distributions (RMDs), allowing your money to grow tax-free throughout your lifetime.
Which IRA is right for you?
Choosing the right IRA depends on your individual circumstances, including your current and expected future tax bracket. While some individuals may fall into a lower tax bracket after retirement, it’s not guaranteed for everyone. Therefore, you should carefully consider your specific financial situation to determine which type of IRA best aligns with your retirement goals.
Where to Open an IRA?
You have many choices when it comes to opening an IRA. Most well-known brokers such as Fidelity, Vanguard, and Schwab allow you to open an IRA with no minimum amount. You can also open an IRA account at a local or online bank of your choice.
Savings Tip: Consider automating your IRA contributions. Setting up direct deposit or recurring transfers from your paycheck or checking account puts the money “out of sight and out of mind”, allowing you to save for retirement without thinking about it.
