Myths About Individual Retirement Accounts
Individual Retirement Accounts (IRAs) have long been a staple for millions of Americans building a nest egg. But misconceptions exist about the accounts causing many to miss out on valuable opportunities. A basic understanding of IRAs can help you maximize your retirement savings’ growth and protect your future.
To begin with, there are two basic types of IRAs:
- Traditional: contributions are tax-deferred. Taxes are assessed only in the future when funds are withdrawn. High-earners face income limits on their deductions if they also have a workplace retirement plan. However, they can still contribute to their traditional IRA, and it will continue to grow tax-deferred.
- Roth: contributions are made after annual taxes are paid. The funds then grow tax-free with no tax obligations due upon withdrawal as long as all other requirements are fulfilled. Limitations on contributions to Roths are based on income: a single person earning $133,000 per year or more, or married couples earning more than $196,000 cannot contribute.
Beyond these two, there are SEP and SIMPLE IRA plans for self-employed people. Contribution limits, taxes, and other rules vary.
The following list describes common IRA myths and mistakes:
- You can only contribute to one type of retirement account in the same year. There are annual contribution limits of $18,000 per year for 401(k)s. People 50 or over are allowed an extra $6,000 annually as a catch-up provision. IRA contributions for 2017 are capped at $5,500 annually with an allowed $1,000 extra for people 50+. As long as you stay within the limits, you can contribute up to $24,000 each year to your 401(k) and traditional or Roth IRAs.
- You never have to touch your IRA money. As soon as you turn 70.5, you are required to take a minimum amount out of your traditional IRA each year and pay income taxes on it. Even though taxes will be due when you begin your annual required minimum distributions (RMD), you are more likely to fall into a lower tax bracket as a retiree with little or no income. If you don’t take your RMD or withdraw too little in any year, you will face a stiff penalty.
- IRA funds can only be withdrawn for retirement. In general, withdrawing funds prematurely from your accounts will trigger penalties. There are two exceptions: you are allowed to withdraw up to $10,000 to purchase your first home. You can also withdraw penalty-free for qualified education expenses for yourself, your child or your spouse. You will still pay taxes on this income but avoid the 10% early withdrawal penalty. Dipping into your principal will hurt potential growth over time for your nest egg. Ideally, you should find other ways to finance these expenses.
- People who are not working cannot contribute to an IRA. For most cases, you must be earning income to contribute an IRA. But the IRS provides an exception to stay-at-home parents and married spouses who file taxes jointly. The spousal IRA requires sufficient household income to match the working spouse’s contributions.
Additional rules apply to IRAs based on specific situations, employment status and income levels. Meet with a trusted financial advisor and tax expert to learn how to build a solid nest egg.
At Silverman Financial, we work with you to develop a comprehensive retirement plan that is balanced, diversified and based on your personal needs and goals.