Retirement may seem like it is a distant fuzzy target, but talk to any successful retired person, and they will tell you that it took a lot of planning and saving to reach financial independence. Financial independence is when you have enough money saved or invested to create a stream of income for you to live off of. You may or may not choose to work in retirement, but it will be because you want to work and not because you have to work.
As a financial coach I’m not going to tell you that everyone must have an IRA (or Individual Retirement Account). However if you plan on retiring someday – and I think we all want to – an IRA can help you get there. There are two types of IRAs available for investors: Traditional or Roth. Each type of account has different features and benefits which we’ll get into in just a minute.
Choose a Traditional IRA
One of the major benefits of a Traditional IRA is that it allows you to defer paying taxes on earned income as well as investment earnings. This means investors don’t pay taxes on contributions, at least not right away. If you make $2,500 you can contribute $2,500 into a Traditional IRA and you may be able to deduct it on your income taxes (subject to earnings and other qualifications).
All investment earnings (i.e. interest, dividends and capital gains) accumulated over the years also remain in the account tax free…until you retire. You will have to pay taxes on the withdrawals once you start receiving distributions from the account. In a nutshell, you contribute to the account pre-tax, but you will be taxed when you make withdrawals.
Opt for a Roth IRA
A Roth IRA is the exact opposite when it comes to taxes. In this type of retirement account investors pay tax upfront on all contributions, and if you follow the IRS rules, you receive all the money tax free during retirement. This is a major benefit of contributing to a Roth IRA.
During retirement, when you start receiving distributions you won’t have to pay any additional taxes on the income or earnings in the account. All the earnings on your investments in the account (i.e. interest, dividends and capital gains) that have accumulated over the years are also completely tax free – both in the present as well as during retirement.
For more information on the benefits of each type of account you can use this comparison chart on the IRS website.
How to contribute into your IRA
When it comes to retirement it’s a good idea to start saving as early as possible. There are two ways to do so: you can contribute regularly with your paycheck schedule or you can invest a lump sum of money into your retirement account.
It may be easier to contribute a little bit every two weeks (or at your paycheck schedule) rather than count on a lump sum such as your year-end bonus or tax return because those types of financial windfalls are not always guaranteed.
If you wait to contribute with a lump sum and you end up owing the government money instead of getting a return or not getting an annual bonus you may end up not contributing to your IRA and that can set back your retirement plans.
When is the contribution deadline?
One important feature of both types of IRAs is the contribution date. All contributions into retirement accounts can be made up until you file your taxes, or April 15 of the current year for the previous year’s income taxes.
As an example, the deadline to contribute to your IRA for 2015 is April 15, 2016. All contributions afterwards will be allocated towards the next year’s income taxes i.e. 2016. Before making any decisions about which type of account is best let’s talk about the types of IRAs available.
As a financial coach I can help you determine which type of account best suits your current savings and future retirement needs.
About Your Richest Life
At Your Richest Life, Katie Brewer, CFP®, believes everyone should have access to financial resources and coaching. For more information on the services offered, contact Katie today.