There are two main types of IRAs: traditional and Roth. Each has its own pros and cons, which makes choosing one over the other more difficult than it seems at first glance. This article will discuss the differences between them and help you to choose which one is right for you by discussing the various aspects that should factor into your decision, such as your income, age, tax bracket, retirement age, and more.
If you make too much money to take advantage of a 401k plan, your best bet is to invest in an Individual Retirement Account (IRA). Traditional IRAs require that you set aside a certain amount each year; once you reach age 70 1⁄2, when traditional IRA contributions are no longer allowed, you can roll your balance into a Roth IRA. Roth IRAs have several benefits over traditional IRAs. For example, under current tax law, up to $5,500 contributed to a Roth IRA will not be taxed annually and future growth on those assets is not taxed either as long as it stays in your account—through withdrawals prior to reaching age 59 1⁄2 will result in taxes.
Should you contribute to an IRA? That depends on your income and other tax-deductible savings accounts you may have. If you’re single and earn less than $72,000 per year, for example, then contributing up to $5,500 (or 100% of your earned income) is a good idea. Beyond that level of earnings, it may be best for you to look into other retirement savings accounts.
The general rule of thumb is that you should try to save 10% of your income for retirement. This might not be feasible for everyone, but it’s a good idea to at least attempt it. If saving 10% seems difficult, start by saving 5%. Remember, even a small amount of savings will add up over time and compound interest makes an enormous difference in your financial picture.
The first step is to ask yourself: how much do I want to save for retirement? Most experts recommend having at least enough money saved up so that you can live off of it entirely if you were to stop working today. This is referred to as your savings number—and in order to figure out what yours should be, start by thinking about how much income you need.
Next, think about how long you’ll need your savings to last. If you plan on retiring at age 65, then you’ll want money saved up until that point. But if you plan on retiring in 25 years, then multiply your number by 25 and add that amount. This will give you an idea of how much money you’ll need for retirement—and thus how much money to aim for in an IRA or other type of savings account.
If you’re between 70 1/2 and 70 7/8, you can no longer contribute to an IRA. However, it is possible for your spouse over age 70 1/2 to contribute up to $5,500 (or $6,500 if they are over 50) into an IRA in your name. This is called a spousal IRA and allows couples over age 70 1/2 who have lost eligibility for their own IRA contributions to continue saving money in a tax-protected account. Can I keep my current employer's plan?: The law does not require employers to offer an IRA program to their employees, so there’s nothing stopping you from switching jobs with a pre-existing retirement savings plan.
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