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Definition of an IRA & What are the different types Available?
In very simple terms, an Individual Retirement Account (IRA) offers you tax benefits if you want to set aside money for your retirement. It is a form of retirement plan provided by financial institutions to help individuals save for retirement and get various tax advantages that ultimately benefit the account holder or their beneficiaries.
The IRA can include different types of assets or investments which you choose. You may choose to invest in stocks, bonds, companies’ funds or even set up a precious metals IRA. You can even appoint the financial institution to act as the custodian of your IRA and manage assets in the account. There are different types of IRAs. Anyone who wants to invest in an IRA should start by understanding the different options available and how they work. There are 4 main types of IRA: Roth, Traditional, SEP and SIMPLE. plus in addition you have what is referred to as an IRA Rollover (i’ll talk about that later on).
A traditional IRA is one that allows you to direct funds to your account and have them grow tax-deferred. This simply means that you will not be taxed until you want to withdraw the money. For you to withdraw from a traditional IRA under 59 ½ years of age, you’ll have to pay income tax together with certain tax penalties. This traditional IRA can be considered by those who have earned income and would like to direct their contributions on a regular basis. There are cases where your income tax bill will reduce if you direct part of your earnings to a traditional IRA.
Traditional IRAs are the most common and it’s where cash contributed to the account is not taxed until you withdraw it. This means that money will continue accumulating in your account and when the time comes to take it out, you will pay taxes for it. If you decide to withdraw the money before you are 59 ½ years old you are also going to pay a penalty tax in addition to the other taxes that area due. There is a contribution limit that is set by the government for every tax year. As of 2014, the contribution limit was set at $5,500.
The biggest difference between Roth and Traditional IRAs is in the tax benefits offered. With the Roth IRA, you invest money that has already been taxed in your account. But since you don’t get to invest in untaxed money, you benefit in the long run when the time comes to withdraw it. You don’t get to pay income taxes when withdrawing the money from your Roth IRA, but this is subject to certain conditions. For instance, you must have reached age 59 ½ to be able to withdraw from your Roth IRA without paying any taxes. If you want to withdraw early, expect to pay a penalty the same way you would do if you had a Traditional IRA. But there are cases where early withdrawals from the Roth IRA are not penalized. For instance, if you are using the money to buy a first home or recover from a disability, you will not be taxed. But the contribution limit is the same as that of the Traditional individual retirement account. You need to consider the pros and cons of each account before choosing to invest for your retirement.
Most people consider the Roth IRA to be a better investment option compared to the traditional IRAs. This is because a Roth retirement account allows the investor to contribute cash without a tax deduction and then when you reach 59 ½ years, you can withdraw it without paying a penny in taxes. But the contribution limits are the same as those on the traditional account. There are also cases where investors who are more than 50 years old are allowed to deposit more money in their IRA.
The table below is courtesy of Fidelity.com who clearly explain the difference between a Roth and a Traditional individual retirement account
|Roth IRA||Traditional IRA|
|Tax benefits||Tax-free growth and tax-free qualified withdrawals.||Tax-deferred growth and tax-deductible contributions.|
|Age requirements||Contribute at any age.||Contribute until you’re 70½.|
|Income requirements||Your income affects how much you can contribute. See current limits.||Your income does not affect how much you can contribute.|
|Withdrawal taxes||You won’t pay taxes when you withdraw your contributions, and you won’t pay federal taxes on your earnings, as long as the five-year aging requirement has been met.||You will pay taxes when you withdraw your pre-tax contributions and when you withdraw any earnings.|
|Early-withdrawal penalties||If you make withdrawals before you’re 59½, you might have to pay taxes on your earnings plus a 10% additional tax.||If you make withdrawals before you’re 59½, you might have to pay a 10% penalty.|
|Minimum required distributions (MRDs)||MRDs do not apply during your lifetime.||MRDs must be taken starting in the year you turn 70½|
The Simplified Employee Pension Individual Retirement Account is more or less like a Traditional IRA with the major difference being that it offers the investor higher contribution limits. With this type of individual retirement account, a married couple who receive quite a high income, say $250,000 can make up to $100,000 in contributions to their SEP IRA. However with this type of account, early withdrawals are not allowed.
SIMPLE IRA stands for the Savings Incentive Match Plan for Employees. It is usually set up by small employers to offer their employees a suitable retirement plan. Like the SEP IRA, this one also has a higher contribution limit. As of 2012, investors were allowed to contribute up to $11,500 and an even higher limit was set for those who were 50 years or older. The employer sponsoring this plan would make a matching contribution depending on a certain percentage of the employee’s earnings. So the combined employee and employer contribution should not exceed the maximum required limit.
How does an IRA Work?
Opening an IRA can be one of the best decisions you ever make as you plan for your retirement. It is simply an account that allows you to enjoy certain tax benefits as you save for your retirement. Anyone can open an IRA so long as you have a taxable income. You’ll just need to visit a financial institution like a bank or a brokerage firm and get them to explain what options they have and then fill some paperwork.
How to fund your IRA account
As soon as you open your IRA, the next step is to fund it. You can invest in stocks, mutual funds, index funds, bonds or any other options available. With a traditional IRA, money is deducted from your earnings. The money in your IRA increases without being taxed. You are only going to be taxed when you withdraw it at retirement. The taxes are deferred until your retirement. That’s why they say the earnings grow on a tax-deferred basis. Upon retirement, individuals are usually in a lower tax bracket. The amount that is taxed will depend on several factors such as the individual’s income as well as the tax rate that applies to that year. There are also statutory limits that will apply.
Setting up IRAs
You can contribute money to different IRAs so long as it doesn’t exceed the maximum annual limit. As of 2014, individuals are allowed to contribute up to $5,500 annually to their traditional or Roth IRAs. The limits can increase as you get older. For instance, once you attain the age of 50, you are allowed to contribute a maximum of $6,000. You must be at least 21 to set up an individual retirement account.
The Roth IRA
The major difference between traditional and Roth IRAs is that so long as you have attained 59 ½ years, money that is withdrawn from the account is not subject to income tax. However, if you decide to make an early withdrawal, you will face the same penalties that apply to traditional IRAs. However, you will not pay any penalties for early withdrawals if the money will be used for a first home purchase.
There are many different types of IRAs and it’s important to understand how each one of them works before you choose to open any account. Opening multiple IRA accounts can help you to diversify your investment but you may also consider consolidating them to avoid paying multiple maintenance charges.
How many ira accounts can you have?
How many IRA accounts can one person have? You are allowed to contribute to more than one IRA. There are situations where you may end up with multiple ones. For instance, if you inherited one but you already had one of your own, you may have to send contributions to both. You can even have a traditional IRA as well as a Roth and direct funds to both in the same tax year.
However, you must not contribute more than the annual maximum amount. This is a limit that is set on all accounts in any given tax year. So all the money you deposited across all the IRAs must not exceed this limit. In 2011, the maximum contribution limit was set as $5,000. This means that if you deposited $4,000 in your traditional IRA, you can only deposit a total of $1,000 in your remaining ones. As at 2014, the maximum contribution per IRA beneficiary was set as $5,500 which means that no matter how many you own, you are not allowed to contribute more than this amount per tax year. The limits do not change whether it is for a Roth or traditional individual retirement account.
Disadvantages of maintaining multiple IRAs
Keeping multiple accounts can be a good way to diversify your investments. You can choose to invest in stocks in one IRA and then open another like a mutual fund. However, multiple IRAs come with various disadvantages. As you choose to open multiple accounts, consider the cost of maintaining them. Costs such as commissions, custodial fees and other additional charges may make it expensive to own multiple accounts. With every IRA, you’ll have a separate custodian. That means you’ll have to pay the custodial fee annually which can be as high as $50. This means that the annual fees will increase if you have more IRA accounts. That’s why many people choose to consolidate their IRA assets in order to have a few accounts. Consolidation combines the different accounts into one that can meet the individual’s investment needs.
As an investor, you are allowed to choose how much you want to contribute to each account you own. You are even allowed to liquidate any of the accounts that are not performing well and maintain the rest. These are decisions you need to make wisely. Setting up multiple IRAs is usually expensive and consolidation is a great way to save on costs.
Is Investing in Gold for Your IRA a Good Idea?
Have you been thinking of investing your retirement savings in precious metals? Many investors are pulling away from the stock market for a variety of reasons. For one, the risk of inflation is undermining the stock market and secondly, safer investment options are giving very small returns. Investing in gold has been considered a smart move for several reasons.
First of all, gold can never be devalued, unlike the dollar. Unlike the stock market, the price of gold is something the government cannot manipulate easily. You have full control of your savings and investments if you choose to invest in gold. There’s absolutely no risk of losing your investments because of government bonds and mutual funds.
It’s a fact that the prices of gold are not affected by inflation. When paper assets are devalued, there’s a high chance the price of gold is increasing. Adding gold to a retirement portfolio not only helps an individual to diversify their assets but also acts as a guard against inflation.
Physical gold can help to reduce the risk of losing your retirement savings because of inflation especially if you are planning on investing in the long term. It is a smart choice for those people who want to invest a lot of funds into their IRAs and distribute them in different forms of investing.
A gold IRA is simply an individual retirement account that allows you to invest in physical gold instead of the paper-based stocks, bonds, and cash. But for you to convert your IRA funds into gold, you’ll need to find a suitable broker or custodian. Custodians are usually commercial banks, brokerage firms and other institutions that have been approved by Federal agencies to provide their custodial services to individuals. There are a number of financial institutions that offer self-directed IRAs which you can invest in gold. The broker or custodian will create and manage your account and even store the actual gold.
However, there are certain regulations that qualify the gold that can be held in an IRA. For instance, the gold bars or coins should meet certain IRS fineness standards in order to be held in the account. The gold must also be held by the IRA trustee or custodian and not the account owner. Additionally, gold coins and bars should be stored in a depository that is approved by the IRS.
What are IRA Custodial Fees?
Individual retirement accounts are held by financial institutions such as commercial banks, retail brokers, and investors. These financial institutions or groups of people are referred to as custodians. The commercial institution or brokerage that holds the IRA usually charges a custodial fee. While you can manage your own IRA, there are activities that you cannot manage to perform on your own. The custodial fee covers the cost of managing the account, safekeeping or any changes that need to be made to the IRA.
What do custodians do?
Custodians perform many roles. They maintain all the records pertaining to your account and also report withdrawals to the Internal Revenue Service annually on your behalf. In some cases, the custodian can be responsible for investing the assets in the IRA.
How much should you pay?
It is important to understand the custodial fee charged by the financial institution that will be managing your account. Know how it is calculated and compare with what other institutions are offering in order to get the best deal. There are several factors that affect how much you are going to pay for custodial services; they include things like the rate rival firms are charging and the kind of service you require. Most custodians charge an annual fee of between $20 and $50. This amount can be deducted from your account as an investment expense. You can pay this amount via check if you wish.
Other than the custodial fees, you can expect other additional expenses when you set up your IRA. There are custodians that charge management fees if you choose to give them the responsibility to manage your account. The amount may vary from 1 to 2 percent of your account value annually. Other charges such as the stock, commissions and transaction fees may apply.
Ways to save on custodial fees
There are cases where the custodial fees will be waived by the financial institution especially if you are a long time customer if you have other accounts with the bank or you meet a certain minimum level of investment. Starting your IRA with a specific minimum amount of money can also save you from paying custodial fees. There are also online financial institutions that do not charge any fees for custodial services. You can also avoid paying custodial fees by setting up an automatic transfer of funds from your bank account to the IRA. Know what options the financial institution offers to waive custodial fees.