Did you know that, in order to retire, you need at least 80 percent of your current income every year to retire? This means that if you made $50,000 a year and you live thirty years after retirement, you’ll need about $1.2 million in your retirement account. This may seem like a daunting number, but a traditional IRA can help you to achieve that goal.
A traditional IRA is a form of retirement savings account that can help you reach your retirement goals on time. Read on to learn more about these accounts and what your options are when it comes to setting one up.
What Is an IRA?
An individual retirement account, or IRA, is more or less what it says on the tin – an account that you can use to build up savings for your retirement. IRAs come in a few primary types: traditional, Roth, SIMPLE, SEP, and rollover. And unlike 401(k) plans, your IRA is not employer-sponsored; it’s an account you contribute to on your own terms.
Traditional IRAs are classified as a pre-tax account, meaning 100 percent of your contributions stay in that account until it’s time to withdraw the funds. Even if the income you’re contributing has already been taxed, you’ll get a deduction on your taxes to put that money back in your pocket. When you withdraw your funds from your IRA, you’ll have to pay income tax on them.
Roth IRA vs. Traditional IRA vs. Rollover IRA
There are three common types of IRAs: traditional, Roth, and rollover. As we mentioned, traditional IRAs are pre-tax accounts that wait to charge income tax until the time you make the withdrawal from the account in retirement.
Roth IRAs are after-tax accounts, meaning you pay income tax on the money you contribute at the time you add it to the account. This can be a good option for younger people starting retirement accounts, since their tax brackets are likely to be lower at the beginning of their careers than when they retire.
Rollover IRAs are a form of traditional IRA that moves money from another type of retirement account into an IRA. For instance, you might move money from a 401(k) account you held with a previous employer into an IRA you control.
SIMPLE and SEP IRAs
There are also two less common types of IRAs: SIMPLE and SEP IRAs. Both of these types of accounts are employer-sponsored benefits, so individuals cannot open them on their own.
Savings incentive match plan for employees (SIMPLE) IRAs are a match retirement option that businesses with fewer than 100 employees can use. Your employer may opt to contribute 2 or 3 percent of your salary to this account each year, provided you commit to contributing the same.
Simplified employee pension (SEP) IRAs use these accounts as a way to manage pensions for their former employees. Your employer can contribute to your IRA, as can you, but there is no match element included with these accounts.
Benefits of an IRA
When you’re looking at the different types of retirement accounts, why should you choose an IRA over some of the other options available?
For one thing, anyone can open and contribute to an IRA account, unlike some of the other retirement accounts. There are no age or income limits on these accounts, so you can work towards your retirement savings at your own pace, no matter what that pace may be.
If you choose to open a traditional IRA, you could also get a break on your taxes during the years you contribute. You get the benefit of having that extra income in retirement, growing and improving your retirement fund. And best of all, you can contribute to an IRA regardless of whatever retirement plan your employer may or may not offer.
IRA Contribution Limits
When you’re contributing to a traditional IRA, it’s important to note that there are annual contribution limits. Your contribution limit will depend in part on your age – specifically, if you’re over or under 50 years old. Older adults who are closer to retirement can contribute more to their IRAs than younger adults.
In 2022, the annual contribution limit to IRAs is $6,000 for people under 50. If you’re over 50, you can contribute an additional $1,000 for a total limit of $7,000 each year. Keep in mind that if you earn $75,000 a year and you contribute $6,000 to your traditional IRA, your taxable income will drop to $69,000 for that year.
How Withdrawals Work
You might not be surprised to learn that there are also rules surrounding when and how you can draw money from your IRA. Once you start drawing funds from your traditional IRA, you’ll have to pay taxes on them. You’ll be taxed based on your tax bracket at the time of your retirement.
If you withdraw from your IRA before you turn 59 and a half, you’ll have to pay taxes on the funds then, plus a 10 percent penalty. Once you reach age 72, you must start drawing some money from your traditional IRA. These are called required minimum distributions and will be calculated based on your life expectancy.
Learn More About the Traditional IRA
A traditional IRA can be a fantastic option for saving for retirement and growing your nest egg. You don’t have to pay taxes on these funds until you withdraw them, and they aren’t tied to any employer.
If you’d like to learn more about the traditional IRA, check out the rest of our site at Bogart Wealth. When it’s time to start planning for retirement, transfer your wealth to the next generation, or investigate your best options, we believe you should ask tough questions. Contact an advisor today and discover how we can be your answer.