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Could an IRA Enhance Your Financial Future?

IRAs are special retirement savings accounts for individuals -- so they are not associated with an employer sponsored retirement plan such as a pension plan or 401k.

There are two basic types of IRAs -- Traditional and Roth IRAs. “The primary difference between the two is how income taxes are treated on annual contributions and distributions or withdrawals,” explains John Sledgianowski, a Relationship Manager with AAFMAA Wealth Management & Trust LLC (AWM&T).

How IRAs Work

You can open an IRA at most banks, credit unions or other financial institutions. However, they are also available through online brokers, mutual fund providers and other investment companies. To contribute, you must have earned income during the contribution year. For 2020, the annual contribution limit for either type of IRA is $6,000. If you are 50 or older, you can contribute an additional $1,000 per year. You have until the tax filing deadline to make your contribution, which is April 15 this year.

Both types of accounts have gross income limits. If you or your spouse do not participate in a plan covered by work then you can contribute the maximum amount to a traditional IRA each year. If your modified adjusted gross income exceeds certain thresholds in certain situations, your contribution amount may be reduced or completely eliminated. This can be impacted if you or your spouse are covered by certain employer-sponsored retirement plans. Check with your tax or financial advisor to see if these limits apply to your situation.

Tax Differences

Annual contributions to a Traditional IRA are tax-free or pre-tax, and excluded from your income on your annual tax return. Contributions to a Roth IRA are NOT tax-free and are included as part of your income on your annual tax return.

When you withdraw from a Traditional IRA in retirement both your contributions and the growth the account has experienced over the years is considered income and is taxed at your marginal tax rate. In addition, once you reach 72, you are required to take required minimum distribution (RMDs) from a Traditional IRA. “If you withdraw from a Roth IRA in retirement after holding the account for more than 5 years, neither the contributions nor the growth are taxed. Plus, there are no required RMDs for a Roth IRA,” says Sledgianowski.

The Fine Print

There are several characteristics of IRAs that could cause you problems and may impact the fund’s value.

Penalties. Not only does each type of IRA have strict requirements for how much you can contribute, they also have rules on how and when you are permitted to make withdrawals or distributions.
Taxes. Withdrawals from a Traditional IRA will be taxed at your marginal income tax rate, so a large distribution could bump you up into a higher marginal tax bracket and have an impact on how much of your Social Security benefit will be taxed.
Fees. There are many different types of fees that may be imposed by the institutions holding the assets in your IRA. “Fees are part of doing business and are compensation for the service provided by an investment manager or brokerage house,” says Sledgianowski. “However, you should be aware of the fees ahead of time.”
Products. Holding the wrong type of investment products in your IRA could keep it from growing to its maximum potential. “You should review the investment mix with your Financial Advisor at least annually to make sure your IRA is positioned for growth,” says Sledgianowski.

Maximizing Your IRA

There are a few common sense tips that can help you grow your nest egg and maximize the value of your IRA, Sledgianowski says.

Start investing early. Time in the market will allow you to take advantage of the market’s long-term growth potential.
Contribute the max each year. If you are married, take advantage of contributing to two IRA’s – a spousal IRA is a great advantage.
Think long-term. Make your IRA part of your tax strategy and plan ahead to avoid penalties and fees associated with withdrawals or missing an RMD.