Saving for Retirement Now: 5 Things You Need To Know About IRAs
The journey towards retirement is a long one and planning for the future is often last on our list of daily priorities. While workplaces offer low-maintenance approaches towards retirement savings in the form of 401(k)s, a person can independently maximize their hard-earned money by investing in Individual Retirement Accounts (IRAs).
IRAs are the totality of a person’s bonds, stocks, and mutual funds. IRAs provide investors the opportunity to save beyond their 401(k)s through varying investments, including stock market returns.
“A person should start an IRA when they get their first job because of compound interest, which has been called ‘the 8th wonder of the world,’” says State Farm agent Pam Hansen Alfred.
You can benefit from an IRA throughout your lifetime. Here are 5 things to keep in mind when beginning and growing your IRA.
The Differences Between Traditional and Roth IRAs
The two most common IRAs are traditional and Roth. Traditional IRAs have income limits dependent on your participation in an employer retirement plan. Traditional IRAs require retirees to pay taxes upon their withdrawals. Roth IRAs are available to those that fall under certain income levels dependent on tax filing statuses. The money stored in a Roth IRA is taxed before it is deposited.
For as long as your money is in any IRA, it is tax-free, but how your income taxes fluctuate over time is an important factor when deciding which IRA is best for you.
“It all depends on what you think is going to happen to taxes in the future,” says Alfred. “If you think taxes are going up, then it’s best to pay taxes on your IRA money now and put it into a Roth IRA. If you think taxes are going down or your income is going down considerably in the future, it’s best to put your money into a traditional IRA.”
Where To Invest Your Money: Asset Allocation
The Internal Revenue Service (IRS) sets the contribution limits for IRAs. The annual contribution limit in 2021 is $6,000 for those under 50 years of age and $7,000 for those over 50.
There are many investment options for IRA portfolios. The fundamental investment types are bonds, stocks, and mutual funds. Each propose their own rewards and drawbacks.
Bonds allow you to invest your money in a company, municipality, or government in exchange for interest payments from that entity. Once your bond matures, you receive your money back in full, plus the accumulated interest. Bonds carry a predictable return, but are susceptible to credit, interest rate, inflation, liquidity and call risks.
The payoff for investing in stocks relies upon the invested companies’ earnings. There is money to be had in the stock market, but buying individual company stocks is a calculated, time-consuming process because this investment approach requires persistent analyzation of expense ratios, fund types, and market performance.
Mutual funds are a variety of securities from different companies and industries combined into a diversified portfolio professionally managed for investors. The portfolio of stocks, bonds, and short-term debt still carries risks because securities can lose value and market conditions influence dividends and interest payments.
If you are unsure of where to begin with asset allocation, it is worth leaning on the expertise of a portfolio advisor. It is crucial to keep abreast of potential changes throughout the life of your investments. A portfolio advisor helps advise your investment choices as your life circumstances change. “How you invest depends on risk tolerance and age. It’s a very individual thing,” says Alfred.
The Longer You Keep Your IRAs, the Greater the Rewards
Compound interest is the process of interest in your IRA building upon the principal balance as it is added into the principal throughout the life of your investments. Holding onto your investments for as long as you can accelerates your overall earnings.
Yearly contributions to traditional IRAs reduce your Adjusted Gross Income (AGI) during that tax year. At tax time, you may qualify for deductions thanks to the contribution of these pretax dollars.
Pay Attention to Withdrawal and Distribution Rules
If you select a Roth IRA, you have the option to withdraw your contributions early without penalties. This flexibility comes in handy for unexpected medical expenses, home remodels, or vacations. You cannot withdraw prematurely from a traditional IRA.
Roth IRAs afford this option only for the money you have contributed. The profits derived from dividends and interest can incur income taxes and a 10% early withdrawal penalty. Exceptions include if you are over 59 ½ years old or meet the requirements of the Roth IRA 5-year rule.
Roth IRAs do not carry a Required Minimum Distribution (RMD) for a living investor. Traditional IRAs are a different story. In fact, the traditional IRA’s RMD was subject to recent changes. Alfred elaborates, “When a person had reached 70 ½ before 2020 they were required to take an RMD, meaning the person had to take a certain percentage of their traditional IRA out and pay taxes on the distribution. The RMD requirement was waived for 2020 but has since resumed for 2021. If a person had not reached 70 ½ by January of 2020, then the RMD age had changed to 72.”
Alfred cautions, “It is very important to pay attention to these rules because if you don’t take any or enough distribution, you are taxed at 50%!”
Choices for Managing Your Investments
The rules, rates, and market conditions pertaining to IRA investments can feel intimidating. If you are looking for professional support from a portfolio advisor, many companies provide payment flexibility for their services.
“There are many different fees involved in investments. Two main schools of thought with the fees are to pay a one-time sales charge or an annual management fee. Your advisor can share with you the particulars and you can decide what is best for you.”
To learn more about IRAs and best practices for investing in your future, reach out to Pam Hansen Alfred and her team at (406) 453-6010, stop by their offices at 2817 10th Ave. So., or visit www.pamhansenalfred.com.
2817 10th Ave S
Great Falls, MT