A traditional Individual Retirement Account (IRA) can be a great savings tool if you follow the rules.
The Traditional IRA
You can claim a tax benefit when you contribute money to a traditional IRA. Since this tax benefit reduces your taxable income, you won’t pay income tax on the money you set aside in the account. Savings grow tax-deferred. You won’t have to include the interest, gains, or capital returns from the IRA in your annual tax return. When you withdraw funds, the distribution from the IRA is included in your taxable income. It is taxed as ordinary income – meaning you pay taxes later on the money you earn today. Many retirees find themselves in lower tax brackets than they were in when they were working and earning, so you may end up paying a lower tax rate on distributions from your IRA.
The Non-Deductible IRA
A non-deductible IRA is a traditional IRA, but the contributions are not tax-deductible because they are made with after-tax money. The advantage of this option is that the savings will continue to grow tax-deferred until you start taking distributions. The principal portion of these distributions is tax-free in retirement because you already paid taxes on the invested money when you earned it – the growth portion is taxed as ordinary income.
The Roth IRA
The Roth IRA offers potentially tax-free growth and distributions. Unlike the traditional IRA, you do not receive a deduction for your contributions when you make them. This makes these accounts similar to non-deductible IRAs, but there are significant differences in how distributions are taxed.
SEP-IRA Accounts for Employees
SEP-IRAs are a type of employer-sponsored retirement plan. The employer sets up a SEP-IRA plan and then contributes to a traditional IRA established within the SEP-IRA account. These plans are popular among self-employed individuals because they allow for higher contribution limits than regular IRAs.
Employee Savings Match Plans
Simple IRAs are also a type of employer-sponsored retirement plan. They are easier to set up and maintain than 401(k) plans or other retirement plans, but they offer lower contribution limits than other employer-sponsored plans. Simple IRAs allow you to contribute pre-tax money with matching contributions from the employer. Distributions are taxed as ordinary income, and there are penalties for early distributions.
Contribution Limits and Deadlines for IRAs
The total amount you can contribute to a traditional IRA or a Roth IRA each year, or any combination of the two, is limited to $6,000 for 2022 and $6,500 for 2023. You can contribute an additional amount if you are 50 years old or older – up to $1,000 extra.
These limits apply to traditional IRAs, non-deductible IRAs, and Roth IRAs. If you wish to fund both a traditional IRA and a Roth IRA, you can contribute any combination of amounts to each, but the total combined must not exceed the annual limit. For example, you might put $3,000 into a traditional IRA and another $3,000 into a Roth IRA (for 2021 and 2022).
Contributions to a SEP-IRA for 2022 are limited to 25% of the employee’s compensation, or $61,000, whichever is less. The limit for 2023 is $66,000.
You can contribute to an IRA at any time during the year. After the year ends, you can still make a contribution for the prior year to an IRA as long as the contribution is made by the tax filing deadline in April.
For
For the previous years and until 2019, the ability to contribute stopped at age 70 1/2 for traditional IRAs. After January 1, 2020, you can continue to contribute to both traditional IRAs and Roth IRAs regardless of your age.
Is an IRA Right for You?
Although it is considered a worthy investment to consider having an IRA, it is not an option for everyone. Individuals’ life circumstances determine the type of IRA they may choose, as well as their ability to contribute to an IRA.
If you do not have enough income to fund IRA contributions, you may need to wait until you have sufficient extra money to do so. If you are young and just starting your career, a retirement fund may be the last thing on your mind. Some people do not start investing in an IRA until later in life.
Regardless of the circumstances or age, an IRA is a way for you to save for retirement while the money you save generates more savings. If you have the potential to do so, an IRA is a good start for your retirement.
When considering an IRA, you should always take into account the tax burden you can bear at the moment, and when you plan to take distributions. Different IRAs can help you manage the taxes on distributions when you can better afford them.
Frequently Asked Questions
How does my IRA account earn money?
There are two ways your IRA account can grow. First, you can add money to it. Second, you can invest the money in your IRA, and as your investments grow, the total value of your IRA account will increase. You may even earn dividends from these investments that you can reinvest.
At what age can I withdraw my money from the IRA without penalty?
You can begin withdrawing money from your IRA without paying a 10% penalty starting at age 59 1/2. If it is a traditional IRA, you will have to pay income tax on your withdrawals.
Source: https://www.thebalancemoney.com/individual-retirement-accounts-3193216
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