Individual Retirement Accounts (IRAs) are not just for younger, full-time workers. Traditional and Roth IRAs may just be a wonderful addition to your in-retirement investment plan.
Unfortunately, for many people nowadays retirement doesn’t mean retirement. No, many folks end up working, usually part-time or intermittently. Sometimes it’s because they want to, but often it’s because they have to financially.
Fewer people receive pensions now compared to in the past. And, some jobs simply didn’t offer good retirement savings plans (or adequate wages to both live on AND save for retirement!). This means that more and more retirees are earning income during at least part of their retirement.
What options are available for saving for your retirement, during your retirement? This is a question most asked by younger retirees who expect to live to a very old age. Women, in particular, might be part of this category. So to anyone asking this question, let’s take a look at the humble IRA.
What are Traditional and Roth IRAs (Individual Retirement Accounts)?
Not investments per se. They are tax-advantaged accounts (like baskets). Inside, you place investments (like eggs). IRAs are available from banks and investment firms, and are very simple to open. Unlike your 401(k) at work, IRAs are not associated with your employer.
They are available in the U.S.. I’m not sure if there are any similar products in other countries. If you’re not from the U.S., please leave the name of a similar account/product offered in your country (don’t forget to include the name of the country).
There are two types of IRA: Traditional and Roth. Both have annual contribution limits, a rule that you have to have earned income to contribute, and early withdrawal penalties. But they work quite differently in some respects, so we’ll go over the key features of each here.
IRAs have various rules. Please check out the current details in this IRS article.
Traditional IRAs work a lot like 401(k) plans (except that they are not tied to your employer). You deduct the amount you put into it from your current year’s income, so it goes in untaxed. This means that you can put more money in and get more of your money earning returns. Naturally, the IRS wants its due eventually.
With Traditional IRAs, the IRS taxes your withdrawals (during your retirement years). This includes both the amount you contributed AND any/all returns your money made. Plus, you must make withdrawals from your Traditional IRA (so the IRS gets its taxes) in the year you turn 70.5 (weird age, I know). This is called Required Minimum Distributions (RMD).
Roth IRAs, on the other hand, work like this: You put in money that was already taxed that year, like you would a normal investment account. But, here’s the magic: The IRS considers itself fully satisfied. This means that you don’t pay any tax when you withdraw your money (during your retirement years), including on any/all returns! You are also not required to take withdrawals from your Roth IRA (unlike with the Traditional IRA).
The Roth IRA is also special for two other reasons:
Penalty-free withdrawal of contributions
Because you’ve already paid taxes on your Roth IRA contributions, you won’t be penalized or taxed if you withdraw it before age 59.5. This is a great back-up safety-net for folks with an inadequate Emergency Fund. Try not to have to use it, but it’s comforting to know it’s an option.
Ability to contribute after age 70.5
Unlike with a Traditional IRA, you can make contributions to a Roth IRA regardless of your age. It a good account to have if you are only partially retired and want to continue investing for your future retirement years. Note that you can’t be fully retired. You must have earned income in order to contribute.
I highly encourage you to research both Traditional and Roth IRAs, especially if you don’t already have one or both. They are great accounts for holding various other investments that we’ve discussed here in this “How to Invest…” series. For example, you could hold a Target Retirement Date fund inside of either type of IRA. IRAs are one of the few times the Government gives you a break, so consider how they might work for you both before and during your retirement years.
–Good luck, we’re all gonna need it!
Feature Image Credit: Steve Buissinne