IRA Basics

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

What Is An IRA?

An Individual Retirement Account (IRA) is a tax-advantaged investment tool designed to help individuals save for retirement. It offers potential tax benefits, either upfront through tax-deductible contributions (Traditional IRA) or at retirement with tax-free withdrawals (Roth IRA).

How Does An IRA Work?

An IRA works by allowing individuals to contribute a portion of their income into a dedicated account. This account can hold various investments like stocks, bonds, mutual funds, and more. The key features include:

  1. Contribution Limits: The IRS sets annual limits on how much you can contribute.
  2. Tax Advantages: Traditional IRAs offer tax-deferred growth, meaning you pay taxes upon withdrawal. Roth IRAs provide tax-free growth, with contributions made with after-tax dollars.
  3. Withdrawal Rules: Withdrawals can be made after age 59½ without penalty in most cases, and mandatory withdrawals are required at age 73 for Traditional IRAs.
Iras

Do IRAs Earn Interest?

IRAs can earn interest but are not limited to interest-bearing accounts like savings accounts. The interest earned depends on the types of investments held within the IRA. For example, if it holds a certificate of deposit (CD), it will earn interest at the CD’s rate.

How Does an IRA Make Money?

An IRA can make money in several ways:

  1. Interest: From interest-bearing assets like CDs or bonds.
  2. Dividends: From dividend-paying stocks or mutual funds.
  3. Capital Gains: From the sale of investments at a higher price than the purchase price.
  4. Compound Growth: Earnings on reinvested dividends, interest, or capital gains.

Understanding IRA Earnings

Earning TypeDescriptionTraditional IRARoth IRA
InterestMoney earned from interest-bearing investmentsTax-deferredTax-free
DividendsEarnings distributed by companies to shareholdersTax-deferredTax-free
Capital GainsProfit from the sale of an investment higher than its purchase priceTax-deferredTax-free
Compound GrowthEarnings on reinvested earningsTax-deferredTax-free

Where Can I Buy An IRA?

 IRAs can be opened at a financial institution (banks, credit unions, and investment firms).

What are the types of IRAs?

There are several types of Individual Retirement Accounts (IRAs) available, including:

  • Traditional IRA: This is the most common type of IRA. Contributions are tax-deductible, and the earnings grow tax-deferred until you withdraw the funds in retirement. At that point, you’ll pay income tax on the distributions.
  • Roth IRA: Contributions to a Roth IRA are made with after-tax dollars, but the earnings grow tax-free. Additionally, qualified distributions (after age 59 1/2) are tax-free. There are income limits on who can contribute to a Roth IRA.
  • SEP IRA: Simplified Employee Pension (SEP) IRAs are for self-employed individuals and small business owners. Contributions are tax-deductible and grow tax-deferred until withdrawal.
  • SIMPLE IRA: Savings Incentive Match Plan for Employees (SIMPLE) IRAs are for small businesses with fewer than 100 employees. Employers must contribute to employee accounts, and employees can contribute as well.
  • Inherited IRA: This is an IRA you inherit after the original account owner’s death. The rules for Inherited IRAs differ depending on whether you are a spouse or non-spouse beneficiary.
  • IRA Annuity: An IRA annuity is a personal pension plan combining the tax benefits of an IRA with the steady income of an annuity.
Iras For Dummies

IRA Pros And Cons

Pros

Assuming you are referring to the IRA (Individual Retirement Account), here are some potential advantages:

  • Tax benefits: Depending on the type of IRA you choose (Traditional or Roth), you may be able to reduce your taxable income now or enjoy tax-free withdrawals in retirement.
  • Investment flexibility: IRAs typically offer many investment options, including stocks, bonds, mutual funds, etc. This allows you to build a diversified portfolio tailored to your goals and risk tolerance.
  • Savings discipline: By contributing to your IRA regularly, you establish a disciplined savings habit that can help you accumulate wealth over time.
  • Estate planning: IRAs can be part of your estate planning strategy, allowing you to designate beneficiaries and potentially pass on tax-advantaged savings to future generations.
  • No required minimum distributions (RMDs) for Roth IRAs Unlike Traditional IRAs, Roth IRAs do not require you to take minimum distributions during your lifetime, which can provide greater flexibility and control over your retirement income.

Cons

Here are some potential disadvantages of IRAs:

  • Contribution limits: IRAs have annual contribution limits, which may limit the amount you can save for retirement each year.
  • Early withdrawal penalties: If you withdraw funds from your IRA before age 59 ½, you may be subject to a 10% early withdrawal penalty in addition to any taxes owed.
  • Required minimum distributions (RMDs): Traditional IRAs require you to take minimum distributions starting at age 73, which can impact your retirement income strategy and tax planning.
  • Limited investment options: While IRAs generally offer various options, some plans may have limited investment choices or high fees that can affect your returns.
  • Complexity: Depending on the type of IRA you choose and your financial situation, managing your account can be complex and require significant time and effort.

How Much Money Do You Need To Open An IRA?

No minimum amount is necessary to establish an IRA, and there are no restrictions on how much money you must put in. Brokerage and advisory firms have their account minimums, but the requirement is frequently lower than a regular taxable account.

IRA Contribution Limits For 2024

IRA TypeStandard Contribution LimitCatch-Up Contribution Limit (Age 50 and over)
Traditional IRA$7,000$8,000
Roth IRA$7,000$8,000
SEP IRALesser of $69,000 or 25% of compensationNo additional catch-up contributions
SIMPLE IRA$16,000$19,500

Key Points:

  • Traditional and Roth IRAs: The standard limit is $7,000, with a catch-up limit of $8,000 for those aged 50 and over.
  • SEP IRA: Contributions are based on a percentage of compensation, up to $69,000. There are no catch-up contributions for SEP IRAs.
  • SIMPLE IRA: The contribution limit is $16,000, with a higher catch-up limit of $19,500 for individuals aged 50 and over.

Can You Lose Money In An IRA?

The stock market is never guaranteed – so even if your IRA is invested in stocks or mutual funds, there’s always a chance that the value of those investments could go down. If the value of your investments decreases, you may end up losing money in your IRA.

Is An Ira A Good Investment For Retirement

Is An IRA Taxable?

Traditional, SEP, and SIMPLE IRAs are taxed as traditional income when you withdraw at retirement age. This means you will pay ordinary income tax on your contributed money and any earnings accumulated over time.

In contrast, a Roth IRA is not taxed when you withdraw at retirement age. This is because the money you contribute has already been taxed. As a result, you will only pay taxes on the earnings accumulated in your account.

Tax Benefits of an Individual Retirement Account

Individual Retirement Accounts (IRAs) offer several tax benefits that can help you save money for retirement. Here are some of the tax advantages of IRAs:

  • Tax-deductible contributions: If you contribute to a Traditional IRA, you may be able to deduct your contributions from your taxable income. This can lower your current tax bill and allow your contributions to grow tax-deferred until you withdraw them in retirement.
  • Tax-free growth: Traditional and Roth IRAs allow your investments to grow tax-free. This means you won’t owe taxes on any interest, dividends, or capital gains your investments earn while they’re in your IRA.
  • Tax-free withdrawals (Roth IRA): If you contribute to a Roth IRA, you won’t get a tax deduction, but your retirement withdrawal will be tax-free. This can be especially beneficial if you expect to be in a higher tax bracket in retirement than you are now.
  • Tax-deferred withdrawals (Traditional IRA): If you contribute to a Traditional IRA, you won’t pay taxes on your contributions upfront, but you will owe taxes on your withdrawals in retirement. However, if you expect to be in a lower tax bracket in retirement than you are now, you could save money on taxes by contributing to a Traditional IRA.

Overall, the tax benefits of IRAs can help you save more money for retirement and keep more of your hard-earned money in your pocket.

When Can I Withdraw From An IRA?

One of the great things about an Individual Retirement Account (IRA) is that you have control over taking distributions from the account.

  • You can start taking distributions at any time after you turn 59 1/2, but you are not required to start taking them until you reach age 73.
  • However, it is essential to note that you may be penalized if you do not start taking distributions by April 1 of the year after you turn 73.
  • If you take an early withdrawal, you will generally be subject to a 10% penalty and any regular income taxes due on the withdrawal. A 72(t) distribution will be the exception to the early withdrawal penalty.

Therefore, it is vital to understand the rules and regulations surrounding IRA withdrawals before making any decisions.

How to Withdraw Money From An IRA After Retirement

Investing in an IRA annuity is one of the best ways to ensure a comfortable retirement. An IRA annuity is a qualified retirement plan with a guaranteed income stream for the rest of your life. The best part is that you can transfer your existing IRA into an annuity, so you don’t have to worry about losing any of your hard-earned savings. A guaranteed income stream allows you to relax and enjoy retirement without worrying about money.

Conclusion

IRAs are a versatile and beneficial tool for retirement savings, offering various ways to grow wealth through interest, dividends, capital gains, and compound growth. Understanding how they work and how they can make money is crucial for effective retirement planning. Contact us today for a free quote.

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questions From Our Readers

What are the benefits of investing in an IRA through a financial institution?

Investing in an IRA through a financial institution can provide tax advantages, potential investment growth, and a diversified portfolio to help save for retirement.

What are traditional IRA contributions?

Traditional IRA contributions are pre-tax contributions to an individual retirement account, which may provide tax benefits and help save for retirement.

What are the benefits of investing in an IRA as part of your retirement plan?

Investing in an IRA as part of your retirement plan can provide additional retirement savings, potential tax benefits, and flexibility in managing your portfolio.

Can you cash out an IRA?

If you withdraw money from an Individual Retirement Account (IRA) before turning 59 and a half, you will usually have to pay taxes and an additional penalty tax of 10%. However, this penalty has some exceptions, such as using IRA funds to pay for medical insurance if you lost your job.

Does my money grow in an IRA?

IRAs, like any other investment, can increase in value over time. You can grow your IRA through annual contributions and by appreciating your investments.

I have a Merrill Edge IRA account; how do I withdraw a large amount, and is it taxable?

To withdraw a large amount from your Merrill Edge IRA account, you would typically initiate the withdrawal online or by contacting Merrill Edge customer service. Withdrawals before age 59 1/2 may incur a 10% early withdrawal penalty in addition to income taxes. However, there are exceptions such as disability, certain medical expenses, or first-time home purchases that may waive the penalty.

I took out money from my IRA to buy out my partner. I still have the money in my account that I owe the IRS but they have not reached out nor I know where to send the money too. What should I do?

If you withdrew money from your IRA and owe taxes on it, it’s important to address this proactively, even if the IRS hasn’t reached out yet, to avoid penalties and accrued interest. Typically, you would report the withdrawal when filing your annual tax return and pay any associated taxes at that time. If you’re unsure about the amount or the process, it’s advisable to consult with a tax professional. They can assist in determining the exact tax liability and guide you through the process of paying it, ensuring compliance and possibly avoiding penalties or interest for late payments.

I’m 73 years old. I have an Ira that earns nothing. Can I roll over in a fixed annuity?

Can you roll over an IRA that isn’t earning much into a fixed annuity at 73 years old? Yes, you can. Rolling over an underperforming IRA into a fixed annuity could be a way to potentially secure a steady income stream, especially as you’re in your retirement years. Fixed annuities can offer a guaranteed return rate, which might be more appealing if your current IRA isn’t meeting your financial goals.

What is better in an IRA, a CD or a fixed annuity?

The better choice depends on your individual financial goals, risk tolerance, and the specifics of the products available to you. Fixed annuities generally offer higher interest rates compared to CDs and may provide more liquidity options. However, annuities often come with longer commitment periods and potential penalties for early withdrawal. CDs are typically considered safer and more straightforward, with fixed terms and FDIC insurance. Annuities might be more suitable for those seeking higher returns and can commit long-term, while CDs are often preferred for their safety and simplicity.

Can I invest my IRA into a flexible-premium deferred annuity?

Absolutely! You can definitely put your IRA money into a flexible-premium deferred annuity.

If I have a 401k and an IRA, are the contribution limits seperate?

Yes, 401(k) and IRA contribution limits are separate. You can contribute to both a 401(k) and an IRA in the same year, and the limits for each type of account do not affect each other. This allows individuals to maximize their retirement savings by utilizing the distinct advantages of both types of accounts.

Are all IRA’s the same?

No, there are several different types of Individual Retirement Accounts (IRAs), each with unique rules and benefits.

Does money in an IRA grow tax-free?

Yesif it’s a Roth IRA. In a Roth IRA, your contributions are made with after-tax dollars, meaning you’ve already paid taxes on the money you put into it. The growth of your investments in a Roth IRA is tax-free, as are the withdrawals, provided certain conditions are met. This includes a five-year holding period and reaching the age of 59½, among other stipulations.

What are the downsides of an IRA?

Limited contribution limits, full taxability when you withdraw from a traditional IRA, and exposure to market loss, which can lead to uncertainty in growth, are some of the potential downsides of an IRA.

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Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

Shawn Plummer is a Chartered Retirement Planning Counselor, insurance agent, and annuity broker with over 14 years of first-hand experience with annuities and insurance. Since beginning his journey in 2009, he has been pivotal in selling and educating about annuities and insurance products. Still, he has also played an instrumental role in training financial advisors for a prestigious Fortune Global 500 insurance company, Allianz. His insights and expertise have made him a sought-after voice in the industry, leading to features in renowned publications such as Time Magazine, Bloomberg, Entrepreneur, Yahoo! Finance, MSN, SmartAsset, The Simple Dollar, U.S. News and World Report, Women’s Health Magazine, and many more. Shawn’s driving ambition? To simplify retirement planning, he ensures his clients understand their choices and secure the best insurance coverage at unbeatable rates.

The Annuity Expert is an independent online insurance agency servicing consumers across the United States. The goal is to help you take the guesswork out of retirement planning and find the best insurance coverage at the cheapest rates

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