IRA and Private Retirement Accounts
Taking a personal approach to planning for your golden years.
Retirement planning is critical if you want a stable financial outlook during your golden years without having to work to support yourself. While employer-based retirement options definitely offer an advantage in helping you prepare, they’re not available to everyone. What’s more, even if you have a 401(k) through your work, it may still be a good idea to take personal steps to prepare in the form of IRAs and personal retirement investment options.
The information below can help you understand the options available for private retirement accounts you can use to prepare for your golden years. All of the options outlined below – whether they’re pre-tax or after-tax – require capital to invest. That means if you’re strapped for cash because your budget is overridden with debt, investing in your future using any of these options may be difficult, at best.
With that in mind, if you’re struggling with debt, it’s usually a good idea to address it first to achieve a financially stable outlook that gives you room to plan properly for the future. If you need help, call us at or complete an online application to request a free confidential financial evaluation with a certified credit counselor.
What is an IRA?
IRA stands for Individual Retirement Account.
This basically refers to a retirement investment that you make privately – i.e. not through your employer like you do with a 401(k) program. It’s YOU investing in YOUR FUTURE.
There are two options for IRA accounts:
- Traditional IRA
- Roth IRA
In both cases, you contribute money and then those contributions are divided by percentage amongst a selection of investments that you select, such as bonds and mutual funds. You usually choose a mix of low-risk / low-yield investments and high-risk / high-yield investments. This helps you achieve a good level of growth while protecting your assets in case of a market downturn.
Which option you choose really depends on what benefits you need. In other words, it’s a really personal decision that you have to make based on your situation – which may be stressful to do if you don’t feel fully informed. The information in the next section can help you understand the differences between the two options, but always remember that if you’re ever in doubt, you should consult a professional financial advisor or planner. Doing so may greatly increase your confidence in the decisions you make.
Traditional IRA vs. Roth IRA
A Roth IRA is actually the more common and popular of the two options for private retirement investment – particularly among younger investors. You make the contributions to the account AFTER taxes. That means you make the contribution with money you receive in your paycheck, rather than having money taken out pre-tax.
The nice thing about this option is that you’ve already paid the taxes on the money put in, so you don’t have to pay taxes on the earning and can make withdrawals tax free after age 59.5 – which can be a huge advantage in your golden years so you aren’t paying taxes on the money that’s effectively supposed to be a substitute for paycheck income. If you take out money before you turn 59½ then you pay a 10 percent tax penalty on the withdrawn amount.
Another advantage is that you can keep making contributions throughout your life. So if you keep working past retirement or even just work part-time, you can put more money into your account to continue to grow. Given increased life expectancies, this can be a critical edge so you don’t end up outliving your investments. A traditional IRA can only be contributed to up to age 70½ AND you have to start taking money out at that age, too.
The only real limitation on a Roth IRA is you can only open this type of account if your gross adjusted income (AGI) isn’t too high. Each year, they set a cap on how much you can make and still contribute to this kind of account. For example, in 2015 individuals cannot make more than $131,000 per year (gross); married couples have to make less than $193,000 in 2015. If you make more than that, then you have to opt for a traditional IRA instead of a Roth.
A traditional IRA functions a little differently by giving you the tax benefits upfront rather than on your withdrawals. This can be particularly advantageous if you don’t have a 401(k) through your employer. If you don’t have a 401(k) you can claim a full tax deduction on your yearly income taxes. So you get the tax benefit upfront, but you’ll be expected to pay taxes on the disbursements after you’ve retired and start to take out money.
If you have an employer-based retirement account like a 401(k) you can still use a traditional IRA and MAY qualify for a full or partial tax deduction, depending on your income. The full or partial distinction depends on how much you make. For instance, in 2015 if you make less than $61,000 per year adjusted gross income (AGI) and file your taxes individually then you get a full deduction; if you make less than $71,000 you qualify for the partial deduction.
There’s also another distinction with traditional IRAs that’s tied to income. Basically, the money you contribute on a traditional IRA will impact the adjusted gross income (AGI) on your taxes. The more you contribute, the more it decreases your AGI. If your AGI is lower, you can often qualify for additional tax benefits and credits that are only available to lower tax brackets. So, for instance, you can use the children’s tax credit where you may not have qualified otherwise if your income is too high.
Both types of IRA accounts have limits to the amount you can contribute. This amounts change yearly so it’s important to check to see how much you can contribute each year. For 2015, you can contribute $5,500 per person if you’re under age 50 or $6,500 if you’re over age 50.
There are two other distinctions between the two accounts. The first has to do with inheritance. If you pass away and there is still money left in your IRA then that money should go to your inheritors. With a Roth IRA, your inheritors won’t pay taxes on that money because you already paid the taxes at the beginning before the contribution. With a traditional IRA your beneficiaries have to pay taxes on the money they inherit.
The last distinction comes with early withdrawals for first time homebuyers. In almost any case no matter which type of account you use, you get a penalty for withdrawing money from the account before age 59½… except when it comes to money you want to withdraw if you’re a first-time homebuyer. For a Roth IRA if you’ve had the account open for 5 years then you can withdraw up to $10,000 tax-free. For a traditional IRA, you can get the same $10,000 as a first-time homebuyer, but you’ll be expected to pay taxes on the money you receive
|Traditional IRA||Roth IRA|
|Cap on contributions||Yes|
Under 50 = $5,550
Over 50 = $6,500
Under 50 = $5,550
Over 50 = $6,500
|Tax deduction on contributions?||Yes|
No 401(k) = full deduction
Have 401(k) = deduction based on AGI
|Eligibility Limitations||Must be under age 70½||Must have AGI less than certain set amounts.|
Individuals = $131,000
Married = $193,000
|Required start for disbursements (withdrawals)||Yes (age 70½)||No|
|Taxes on withdrawals||Yes||Only taxed for early withdrawals (before age 59½) or those made within 5 years of account opening.|
|Beneficiaries pay taxes on inherited accounts?||Yes||No|
|Early (penalty-free) withdrawal for 1st time homebuyers||Yes, but will be required to pay taxes||Yes, but only after account is open 5 years; withdrawal is tax-free|
Converting an IRA
You choose which account you open based on your specific financial situation and which account will work best for you. However, what if your situation changes or you realize you’d have been better using the other option?
Luckily, you have the right to convert your account. You can convert a traditional IRA to a Roth IRA or vice versa. If you’re going from a Roth to a traditional IRA, it’s called “recharacterization” and it has to be done by October 15 each year to count for that years federal income tax return (since a traditional IRA impacts your AGI and can change your tax benefits).
For converting a traditional IRA to a Roth IRA, just be aware that a Roth IRA usually wants you to leave your initial deposit alone for 5 years before you make any withdrawals, so if you’re over age 59½ or you’re planning on becoming a first-time homebuyer in the next few years, then converting the account may cause some issues.
As a final note, you should also be aware that you can roll money from a 401(k) into your Roth IRA. If you quit or lose your job, you don’t have to lose the money you’ve already invested in your retirement. Instead, you pay taxes on that amount and then move the money into your Roth IRA.
What about myRA?
In 2014, President Obama announced a new type of private retirement option known as a myRA. There’s a lot of confusion over what exactly this account is and how it offers different benefits from what you can already get with other private retirement accounts.
According to Forbes, “Fact is, myRA is just a Roth individual retirement account with training wheels.”
Basically, the contributions you make are taken out of your after-tax income. However, you can request your employer to direct deposit a portion of your take-home pay into your myRA retirement account – so it helps the people who have trouble making regular personal retirement contributions on their own.
Those contributions can also be as low as $5. You only need $25 to open the account initially and then you can make $5 contributions to get your retirement investment off the ground. After the account balance reaches $15,000 the account becomes a regular Roth IRA. And just like a Roth IRA, you can take the money out whenever you want by the 10 percent early withdrawal tax penalty.
The one big difference in this account versus a Roth IRA is how the money gets invested. With a Roth IRA, the money you contribute is divided by percentage between different types of investments. By contrast, a myRA only invests in treasury bonds. Bonds are low-risk (bordering on no-risk barring total government and economic collapse) but they don’t produce much yield either (i.e. they’re slow growing). So while your money may be safer, it’s going to take more time for it to grow.