According to at least one article, there are many reasons to retire in Missouri. But what good is finding a great place to retire if you don’t have sufficient financial resources to do so comfortably? If you haven’t created your retirement plan yet, it’s not too late. Instead of relying on Social Security Benefits, you can have a comfortable retirement if you engage in comprehensive retirement planning. Individual Retirement Plans (IRAs) are an easy way to start your plan while saving and investing in your future.
Understanding how an IRA works
An IRA, or individual retirement account, is basically an investment account with various tax benefits. An IRA provides a dependable way to set aside money for retirement. With individual IRAs, you do not have to pay taxes on the earnings from the retirement account. Those earnings can instead be reinvested in order to allow your account to grow exponentially. Then after you reach retirement age and begin to make withdrawals, your tax obligation will depend on the type of IRA you own, your current income and the amount of your withdrawals.
What are the different types of IRAs
There are four kinds of IRAs with various benefits. Traditional and Roth IRAs are established by individuals, whereas Simplified Employee Pensions (SEPs) and Savings Incentive Match Plan for Employees (SIMPLE) are sponsored by employers. Regardless of the type you choose, all IRAs are “fully vested.” This means all of the contributions you make and the earnings you accumulate belong to you, including the contributions made by your employers.
Are there limitations on contributions to IRAs?
The IRS has established limitations on the total amount of annual contributions you can make to an IRA account. These limitations are subject to change each year. For that reason, you should always consult with your retirement planning attorney to determine the current limitations for that year.
In 2018, the maximum contribution for both Traditional and Roth IRAs is $5,500, for individuals under the age of 50. For those over age 50, the limit is $6,500. The maximum contribution for a SEP IRA is $55,000. The limit for a SIMPLE IRA is $12,500 if you are under age 50 and $15,500 if you are older.
What is a traditional IRA?
A traditional IRA is funded with what is referred to as “pre-tax” dollars. This means you are not required to pay any taxes on your contributions or the interest they earn until you begin taking withdrawals at retirement. At that point, each withdrawal you make is taxed as regular income. For example, if you owe 20% tax on your income based on your income and you take a withdrawal of $10,000 during the tax year, you will owe $2,000 in federal and state income tax.
How does a Roth IRA work?
A Roth IRA, however, is funded with “after-tax” dollars. This means that a Roth IRA does not provide tax benefits when it comes to contributions. Instead, the earnings and withdrawals from Roth IRAs are typically tax-free. A major advantage to a Roth IRA is that not only are your earnings allowed to grow tax-free but when you retire and take withdrawals, you pay no income taxes. In essence, you avoid taxes when you contribute to the traditional IRA, but you avoid taxes with the Roth IRA when you withdraw money at retirement.
Be aware of early withdrawal penalties for IRAs
Regardless of the type of IRA you have, you will be subject to an early withdrawal penalty if you take distributions before you reach the age of 59½. With a traditional IRA, the penalty is an additional 10% on top of the income tax you are required to pay on distributions. The Roth IRA also requires that you have owned your IRA for at least five years before you start taking distributions, or else you are charged a penalty. A benefit of a Roth IRA, though, is that you can withdraw your original contributions at any point without penalty. The reason is you have already paid income tax on those funds. Considering these penalties is an important part of retirement planning.
Maximum contributions to employer-sponsored IRAs
The employer-sponsored IRAs (SIMPLE and SEP) are available for employers who meet certain criteria, including self-employed individuals and small business owners. The maximum contribution an employee can make to a SEP IRA is $55,000. The maximum contribution to a SIMPLE IRA is $12,500 if you are under age 50, and $15,500 if you are older than 50.
Join us for a free workshop today! If you have questions regarding IRAs or any other retirement planning matters, please contact the experienced attorneys at Gaughan & Connealy for a consultation. You can contact us either online or by calling us at (913) 262-2000. We are here to help!