Does Your IRA Confuse You? We Can Explain
An individual retirement arrangement, or IRA, is a great way for Americans to save for retirement and enjoy some pretty nice tax benefits at the same time. Unfortunately, IRAs aren't well understood by many Americans, and less than one-fifth of us actively contribute to an IRA. If you want to take a more proactive approach to investing for retirement but aren't sure how to get started, here are some explanations of frequently misunderstood IRA concepts that may be able to help.
How much money can I put in my IRA?
For the 2016 and 2017 tax years, you can deposit up to $5,500 into your IRA, with an additional $1,000 "catch-up" contribution allowed if you're 50 years old or older.
It's also important to point out that these limits are per person, not per account. In other words, if you have more than one IRA, your total contributions cannot exceed these limits.
Image source: Getty Images.
When do I need to make my contribution?
If you notice, I included the 2016 contribution limit in the previous section, even though we're well into 2017 as I write this.
This is because the deadline for IRA contributions isn't until the tax deadline. This means that you can make contributions for the 2016 tax year until your tax return is due on April 18, 2017. For 2017 contributions, you'll have until the 2018 tax deadline.
If you're new to IRA investing, you can use this feature to jump-start your retirement saving. Specifically, if you get started soon, it's completely legal to start an IRA and deposit a total of $11,000 into the account during 2017 ($13,000 if you're 50 or older), if you time it right.
I heard I get a tax break for saving in an IRA. How does that work?
For a traditional IRA, your contributions may be tax deductible during the current tax year. In other words, if you contributed to a traditional IRA in 2016, you might be able to deduct your contributions on the tax return you'll file in 2017. However, any money you withdraw from the account, such as after you retire, will be treated as taxable income.
On the other hand, Roth IRA contributions are not deductible, but your qualified withdrawals will be completely tax-free.
In a nutshell, a traditional IRA can lower your tax bill now, while a Roth IRA can help you avoid taxes in the future.
In addition to these benefits, low-to-middle-income taxpayers may qualify for the Retirement Savings Contributions Credit (also known as the Saver's Credit), which can give you up to $1,000 back in free money, just for saving for retirement.
What if I have a 401(k) at work?
It depends. You can contribute to a traditional IRA every year, even if you're covered by an employer's retirement plan such as a 401(k), 457(b), Thrift Savings, or pension plan.
However, the ability to take a tax deduction for your contributions is limited by your income if you or your spouse are covered by an employer's plan. Here are the current income limitations for the traditional IRA deduction:
|
Tax Filing Status |
2016 Tax Year |
2017 Tax Year |
|---|---|---|
|
Single or head of household |
$61,000-$71,000 |
$62,000-$72,000 |
|
Married filing jointly |
$98,000-$118,000 |
$99,000-$119,000 |
|
Married filing separately |
$0-$10,000 |
$0-$10,000 |
|
Married filing jointly (your spouse has a retirement plan, but you don't) |
$184,000-$194,000 |
$186,000-$196,000 |
|
Married filing separately (If your spouse is covered at work but you're not) |
$0-$10,000 |
$0-$10,000 |
Data source: IRS.
If your AGI is below the lower limit of your range, you can take a full deduction, and if you fall within the range, you can take a partial deduction for your traditional IRA contributions.
Unlike the traditional IRA, the ability to contribute to a Roth IRA does depend on your income, but is not limited just because you have an employer's retirement plan. For the sake of being complete, here are the income limits for making a direct contribution to a Roth IRA:
|
Tax Filing Status |
2016 Tax Year |
2017 Tax Year |
|---|---|---|
|
Single |
$117,000-$132,000 |
$118,000-$133,000 |
|
Married filing jointly |
$184,000-$194,000 |
$186,000-$196,000 |
|
Married filing separately |
$0-$10,000 |
$0-$10,000 |
Data source: IRS.
Can I take a loan from my IRA?
The short answer to this question is no. There is no such thing as an IRA loan. However, there is a way to get around this rule on a short-term (60 days or less) basis by withdrawing your money and depositing it back into a qualified retirement account within 60 days. Here's a discussion of this process if you're interested.
Is there any way I could use my IRA before I retire?
One of the big concerns of new IRA investors is that their money will be "tied up" until retirement. However, that's not always the case.
Two major exceptions are the first-time home purchase and education expense exclusions. Specifically, you can withdraw up to $10,000 from your IRA at any time to be used toward a first-time home purchase for you or someone else. And you can withdraw any amount to pay for qualified higher education expenses.
In addition, if you have a Roth IRA, you are free to withdraw your original contributions at any time and for any reason. From the IRS's perspective, you didn't get a tax deduction for your Roth contributions, so they're yours to do with as you wish. However, any investment gains are off-limits.
As a final point, your money is never "tied up." You can take money out of your IRA whenever you want, but if it's not a qualified withdrawal like the ones I just discussed, the IRS can assess a 10% early withdrawal penalty. So, the worst-case scenario if you need your IRA funds before you turn 59 1/2, you'll have to pay 10% of the withdrawal amount to the IRS.
What's the best way to invest -- stocks, mutual funds, bonds?
There's no one-size-fits-all answer to this question, but in a nutshell, you need exposure to both stocks and bonds. Whether you get this exposure from individual stocks or from mutual funds and ETFs depends on how involved you want to be in the investment process. For most people, funds are the way to go. In fact, billionaire investor Warren Buffett has said that a low-cost S&P 500 index fund is the single best investment most people can make.
As far as setting your stock/bond allocations, here's a great guide to asset allocation that can help you get started.
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