IRA stands for individual retirement account. IRAs help you save money for retirement in a tax-advantaged way. This means that you get valuable tax breaks when you invest in an IRA.
To ensure that most people have enough money to see them through retirement, the federal government has created a few different ways to encourage saving, primarily by offering tax breaks. An IRA, which is designed for long-term retirement saving, is one of those ways.
Anyone can open an IRA account through a broker or an online brokerage account. Then you can purchase a variety of investments and financial instruments inside of your IRA account, and any earnings grow tax-free. There are a few rules, like how much you can contribute each year and when you can start accessing the funds, that we’ll explain below.
We all need to save in order to have a healthy retirement, so we might as well do it in an account that helps us reduce our taxes. It doesn’t take much effort to begin building a savings vehicle that can help you realize your retirement goals.
With traditional IRAs, you are allowed to make pretax contributions, which reduce your taxable income for the year. But you will pay taxes when you withdraw the funds in retirement. You end up paying taxes either way, so what’s the difference? Well, most people are in a lower tax bracket after they retire than they were during their working years. Among other benefits, that means your retirement income will be taxed at a lower rate. In addition, the money that would have been used to pay taxes has a chance to grow in your account over the years, so there’s considerably more money in the account when you reach retirement age and start withdrawals. Roth IRAs also grow tax free, and they offer more flexible accounts since you put in after-tax funds.
When it comes to saving for retirement, the earlier you start, the better. Since investments in an IRA grow tax-free (Roth) or tax-deferred (traditional), the longer they can sit untouched, the more they will compound and grow. Some people even start IRAs for their children while they are still in school to give them a head start. But most people truly begin saving during their prime working years. As soon as you have extra savings that you feel comfortable putting away, it’s time to think about setting up an IRA.
Yes. IRAs are tax-advantaged holding accounts for investments, and with investments, there is always a risk. If your portfolio declines in value, your IRA will lose money. While diversification does not guarantee any results, a well-diversified IRA is a prudent way to save for retirement. If you have questions or would like help building a well-balanced IRA for your specific needs, you should speak with a financial services professional.
Technically, there’s no limit to the number of IRAs you can have, but the contribution limits apply to all of your accounts combined. In 2023, the yearly contribution limits are $6,500 if you are under age 50, and $7,500 if you are age 50 or over. This limit is subject to change. There are a few reasons some people may want to have multiple IRA accounts, but generally one or two is plenty.
401(k) accounts have similar tax advantages, but they are almost always tied to an employer. Many employers match some of the contributions you put in your 401(k), giving you another way to increase your retirement savings. And the contribution limits are higher: $22,500 if you are under age 50, plus an additional $7,500 in catch-up contributions if you are 50 or older. If a 401(k) is an option at work, you should take advantage of it.
While all IRAs have the same goal—providing tax breaks to encourage people to save for retirement—there are key differences in how they help you get there. Understanding how taxes apply and investments grow can make all the difference when it comes time to reap the benefits in your golden years.
Contributions into a traditional IRA are tax-deductible on both federal and state tax returns. In addition, all growth within the account is tax free. That can be huge. In fact, contributing just $6,000 a year could lead to over $1 million in retirement savings, all growing tax free. You should avoid accessing this money until you are 59½. There are ways to get some of the money out sooner, but you’ll likely have to pay a 10% IRS tax penalty. When you withdraw the funds in retirement, they are taxed as ordinary income.
Roth IRAs work almost backward when compared with traditional IRAs. Your contributions up front are funded with earned income on which you’ve already paid taxes. When you start withdrawing your funds, those withdrawals are tax free. Roth IRAs also have fewer restrictions on drawing money out early. You can pull contributions out any time, but accessing earnings will trigger taxes and penalties unless you are over age 59½ and have held the account for at least five years. Roth IRAs also don’t offer quite as much of a tax advantage as a traditional IRA, and there are eligibility requirements. Your income must not exceed a certain amount designated by the federal government, and funds contributed must be earned income. A financial services professional can help you decide whether a traditional or a Roth IRA might be best for you.
SEP (Simplified Employee Pension Plan) and SIMPLE (Savings Incentive Match Plan for Employees) IRAs are products that are employer sponsored, and more like 401(k)s. They are generally used by smaller, family-run businesses to help their employees save for retirement.
When it comes down to it, the main choice is between a traditional or a Roth IRA, and it really depends on when you want to pay taxes: now or later. Here’s a simple comparison between the two:
|Traditional IRA||Roth IRA|
|Eligibility requirements||Anyone with an earned income||Must be below federal modified adjusted gross income (MAGI) levels|
Taxes on growth
|Money in||No taxes on contributions or growth||Contributions are after-tax, but growth is not taxed|
|Money out||Taxed as income on withdrawal||No taxes on withdrawals in retirement|
|When can you start?||Any age||Any age|
Contribution limits under 50 (2023)
over 50 (2023)
|Withdrawals1||Penalty before age 59½; required minimum distributions start at age 73*||Penalty for withdrawals on earnings before age 59½ and a 5-year holding period|
When you’re ready, starting an IRA for yourself or a dependent is a pretty simple process. Just follow the steps outlined below.
You can open an IRA at a lot of places, like banks, brokerages that offer hands-on management, or an online investment account. Each comes with pros and cons, and fees will change depending on how much assistance you’re getting. Once you know where you’re going to set up your account, you’ll simply have to choose the type.
Once set up, you can start funding your account immediately. Remember, there is a yearly contribution limit. It’s generally advised that you put in the maximum allowed amount every year if you can afford to do so. That will ensure maximum growth of your account over time.
To avoid tax penalties, you’ll need to wait until age 59½ before withdrawing funds from an IRA. (In certain specific instances, you may be able to make a hardship withdrawal without paying the 10% tax penalty. But you will owe ordinary taxes on that money.) Remember, this savings account is for your retirement, so it’s best to wait. With a traditional IRA, you will have to begin required minimum distributions (RMDs) by age 73,* so you have some wiggle room to keep your investments growing should you work longer, or should you have other savings to fund your early retirement.
When you contribute funds to an IRA, you’ll need to select investments. If you’d like help setting up or funding an IRA, or would like professional guidance on where to invest your hard-earned savings, a financial services professional at NYLIFE Securities can help.
1Exceptions apply. Consult a tax professional for full rules regarding withdrawals.
* IRA owners who turn 72 in 2023 (those born in 1951) do not have an RMD due this year. Instead, they will need to start taking RMDs when they attain age 73 in 2024. This RMD must be satisfied before their new required beginning date of April 1, 2025. They should keep in mind that if they choose to delay their RMDs until 2025, they will have two RMDs to withdraw in 2025. Their 2024 RMD must be distributed by April 1, 2025, and their 2025 RMD must be distributed by December 31, 2025.
Neither New York Life Insurance Company nor its agents provide tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions.