Planning for retirement is one of the most important steps you can take, and it is crucial to understand the types of accounts available to you. Individual Retirement Accounts (IRAs) are a terrific way to get started and here at Auburn Savings Bank we want to ensure you have all the information you need to make the best decisions for your future.
What is an IRA?
An Individual Retirement Account (IRA) is a special type of savings account with the sole purpose to help you save for retirement with tax advantages. There are several types of IRA accounts, each one offering different benefits. This makes it possible to choose an account that is tailored to your individual needs.
Types of IRAs
Traditional IRA
- Tax Advantages: Contributions to a Traditional IRA may be tax-deductible, which reduces your taxable income for the year.
- Growth: Your investments grow tax-free. This means that you will not pay taxes on your earnings until you withdraw them.
- Withdrawals: When you withdraw from a Traditional IRA your withdrawal is taxed as ordinary income. If you withdraw from your IRA before the age of 59 ½ which is considered an early withdrawal, then you may be subject to paying a 10% penalty on your withdrawal.
- Required Minimum Distribution (RMD): Your must withdraw your RMD at the age of 73.
Roth IRA
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- Tax Advantages: Contributions to a Roth IRA are made with after-tax dollars which means that they are not tax-deductible.
- Growth: Your investments grow tax-free and certain qualified withdrawals in retirement are also tax-free.
- Withdrawals: There are two main options for withdrawals from a Roth account. Your contributions to the account can be withdrawn at any time without penalties or taxes. Your earnings from the account can be withdrawn after the account has been open for 5 years and you are 59 ½ or older penalty and tax-free.
- Required Minimum Distribution (RMD): There are no RMDs during the account holder’s lifetime.
SEP (Simplified Employee Pension) IRA
A SEP IRA is a savings plan that is designed for small business owners and self-employed individuals.
- Tax Advantages: The contributions to an SEP IRA are tax-deductible for the business responsible for the contribution.
- Growth: As the account holder your earnings grow tax-deferred until withdrawal.
- Withdrawals: Withdrawals from a SEP IRA are like a Traditional IRA in that they are taxed as ordinary income and if you make an early withdrawal, you will incur a 10% penalty.
- Required Minimum Distributions: You must withdraw your RMD at the age of 73.
SIMPLE (Savings Incentive Match Plan for Employees) IRA
A SIMPLE IRA is a savings plan that is designed for small businesses with one hundred or fewer employees.
- Tax Advantages: Like a SEP IRA, contributions are tax-deductible for the employer. Contributions by the employees are made pre-tax, making their taxable income for the year a reduced amount.
- Growth: Your earnings grow tax-deferred until withdrawal.
- Withdrawals: Withdrawals from a SIMPLE IRA are subject to be taxed as ordinary income. An early withdrawal will incur a 10% penalty.
- Required Minimum Distribution: You must withdraw your RMD at the age of 73.
What is an RMD?
A Required Minimum Distribution (RMD) is the minimum amount that you must withdraw from your retirement accounts each year once you reach a certain age. Here are some key points to note about RMDs:
- You must start taking your RMD by April 1st of the year following the year you turn 73 years old. After the first year of taking your RMD you can take your RMD by December 31st for each year following.
- RMDs apply to Traditional IRAs, SEP IRAs, and SIMPLE IRAs. Roth IRAs do not require RMDs during an account holder’s lifetime.
- The amount of your RMD is calculated based on your account balance at the end of the previous year along with a life expectancy factor that the IRS provides.
- RMDs are generally taxed as ordinary income.
- If you fail to your RMD you may be subject to a large penalty on your account.
Choosing the Right Account
Choosing the right IRA account depends on your financial situation and overall goals for retirement. Here are a few factors to consider:
- Your Tax Bracket. If you expect to be in a lower tax bracket in retirement, a Traditional IRA might be beneficial for you. If you expect to be in a higher tax bracket in retirement, a Roth IRA could be more advantageous.
- Income Limits. Roth IRAs have income limits for eligibility. If you are thinking about opening an IRA, be sure to check that you qualify based on your income level.
- Account Flexibility. Consider the flexibility that each account offers you. If you are looking for an account with more flexibility a Roth IRA may be the best option for you since you can access your contributions sooner without a penalty.
Tips for Maximizing Your IRA
- Start Early: The sooner you start thinking about saving for retirement the more time you will have for your investments to grow.
- Make Regular Contributions: By contributing regularly to your retirement accounts you can help build your savings over time.
- Review Regularly: Be sure to review all your retirement accounts regularly to ensure you are still on the right path for your retirement goals.
At Auburn Savings Bank we are dedicated to helping you achieve a stable and enjoyable retirement. To learn more about our IRA options and how we can assist you in planning your future contact one of our Customer Service Representatives today.