Investment Vehicles: IRA’s

Why the account you invest in is just as important as the investments you place in them.

There are three main investment account choices that we in the United States can use to buy and sell securities. It is important to understand the differences before you begin investing. Or if you have already started investing, it is important to educate yourself on the pros and cons of each account type so you can make changes if necessary. These main account types are IRA’s, 401(K)s, and taxable brokerage accounts.

Depending on how you are employed you may deal with variations of these accounts but overall the three types we will discuss apply to many situations. If anyone with a unique situation would like to elaborate on what kind of accounts they use, please join the conversation in the comments section. The best source for learning about these accounts are the people who will be collecting taxes on them, the IRS; please reference the direct source before making any final decisions.

Today we will dive into the details of IRA’s.

IRA Basics:

Traditional IRA

A traditional IRA or “Individual Retirement Account” is a government sponsored account that allows for a tax-advantaged investment for those who contributed money they earned in that current tax year.  The main positive to this account is that the contributions you make are tax-deductible under a certain limit. Meaning if you contribute to the traditional IRA you can report it on your tax return and ultimately you will get back the money that was withheld for those taxes earlier in the year.

This allows someone to contribute more money this year than they would have been able to and that money will then grow until you are ready to use the funds in retirement. This money will then be taxed at whatever income bracket you are in when you begin taking distributions from your account. Additionally there are other LEGAL strategies to avoid paying taxes or at least pay a lower rate, but that is out of the scope of the investing basics today.

Information about Traditional IRA:

  • 2017 Tax Year: Allowed to contribute $5,500 per person, or $6,500 if 50 or older.
  • AGI (Adjusted Gross Income) limits single filers: $62,000 or less full deduction, $62,000-$72,000 partial deduction, $72,000 and above no deduction.
  • Can make contributions up until the tax filing deadline for the previous year.
  • Must start taking distributions at age 70 ½.
  • Penalty-free withdraws at 59 1/2, you will pay taxes.

Roth IRA

A Roth IRA has similarities to the traditional IRA but is very different as well. The IRA is set up once again to encourage investors who have earned income for the year to invest and receive a tax benefit. The traditional IRA helps you save taxes up front and then requires you to pay taxes on distributions later on the money you have invested. The Roth IRA is the opposite situation; you instead pay the taxes upfront now at whatever rate your income bracket puts you in. Then you are allowed to take this money and invest it and from that point on it’s never taxed again. So you start out with a smaller investment on the front end but then have no taxes due on the back end.

Two different strategies, and as most things in finance, it depends on your situation as to which you should use. This can turn into a big debate in the finance world, and there are conflicting opinions. For the scope of the article, I will give you the information on the accounts, and you can make the decision.

Information about Roth IRA:

  • 2017 Tax Year: Allowed to contribute $5,500 per person, or $6,500 if 50 or older.
  • Not Deductible
  • Can make contributions up until the tax filing deadline for the previous year.
  • Not required to take minimum distributions.
  • Can take out contributions you have made at any time penalty free.
  • Can take gains made on investments at 59 ½ penalty free.
  • Qualifying reasons can allow you to take money out early without penalty.
  • AGI (Adjusted Gross Income) limits single filers: $118,000 or less can contribute full amount; $118,000-$133,000 phase out; above $133,000 not eligible.

Other Thoughts

There are other rules and types of IRA’s depending on how you are employed and your specific situation. For most people, the rules are fairly simple once you understand the basics. There are also strategies to contribute to a Roth IRA if your income limit is over the AGI level determined by the IRS. This is called a back door Roth, and I would be happy to cover it if necessary.

There is a lot of information out there on IRA’s, and the internet is a powerful resource to educate yourself. Make sure that you consult with a tax professional if needed and get pointed in the right direction so you can make the decision that works best for you.

This site is about educating and giving a unique perspective on saving and lifestyle. Many younger people starting work today have tremendous power because they have the greatest asset of all TIME. This makes it possible to start investing heavily today and have the possibility to move towards work and life experiences you are more passionate about in future years. Do not feel trapped in feeling that you will need to stay in the same job you are in now forever. All investing does is give you more options tomorrow on how you want to shape your life.

The biggest mistake I see people make is thinking that a retirement account is for when you are “old.”  There are ways to utilize these accounts earlier than the classic “retirement years.” The other big point to take away is that if you are young and motivated today, you can save a lump sum and let it build for 30+ years without adding a dollar and would still have a sizable sum of money to take care of yourself down the road. This leaves the thirty years in between where you won’t feel the pressure to make so much money because you already have your snowball of investments rolling. Instead, you can focus on working on projects you are passionate about and using your income to do the things you really care about.

I plan on going through other account types and investment ideas in future posts.

What Are Your Thoughts?

  1. Do you use the Roth IRA or Traditional IRA?
  2. If you choose to not invest in either what is your reasoning?
  3. If you could go back in time would you use these accounts or avoid them all together?

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