IRA wants you…so don’t deny her!
IRA or Individual Retirement Accounts. The initial answer by the US government to the disappearing pension systems in our society. This is something we need to think about as an IRA is a great way to save money for retirement. So here we cover some of the basics.
I was not savvy enough to contribute to an IRA account until 2014 but have been doing so for myself and my spouse since 2014. It is in addition to my employer 401K account and something to invest in after hitting the employer match and paying off high interest debts as discussed in getting your house in order.
IRA History:
This is a summary from a Forbes article found here:
The IRA established in 1974 (401K’s would not come into play until 1980) when Congress passed the Employee Retirement Income Security Act. In the beginning, an employee could put $1,500 in an IRA account. This grew tax deferred (not taxed until a withdrawal was made). Initially only individuals not covered by employee retirement plans could make contributions.
With the Reagan administration (1981) and the limit was increased to $2,000. The Reagan administration allowed for nonworking spouses to contribute $250 a year. Everyone received a tax deduction for contributions until 1986. Then tax deductions were taken away from high earners. There were more changes over the years getting us to our current limit of $5,500.
The next big change came in 1997, when the Roth IRA was created by Senator Roth. This allowed for after-tax contributions, allowing money in the account to grow tax free. Limits on this increased over the years and in 2001 an extra $1,000 catch-up contribution was allowed for those over 50 years old.
Traditional IRA
A traditional IRA is one where money is placed into the account. The money grows without being taxed. Once taken out the money is taxed at the current income bracket. By not taxing the money as it grows, the money grows faster without a “tax drag”.
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Tax Deductibility
- Money put in today is completely tax deductible if income is below $99,000 if filing married/jointly ($62,000 if filing single).
- The money is partially tax deductible if income is between $99,000 and $119,000 filing married/jointly ($62,000 to 72,000 if filing single).
- The money is not deductible if income is above $119,000 filing married/jointly ($72,000 filing single).
- Contributions can occur until 70 years old.
- There are no income limits
- Withdrawing of the money can start after 59.5 years of age without penalty.
- Money has to be withdrawn starting at 70.5 years of age.
- If money is removed before 59.5 years old there will be a 10% penalty.
- The current contribution limits for a traditional IRA is $5,500 unless over 50 years old, then it is $6,500.
Roth IRA
A Roth IRA is where after-tax dollars are placed into an IRA account and grow tax free. Once the money is taken out there are no further taxes.
- Contributions can be made at any age,
- Withdrawing money can begin at 59.5 years of age.
- There is no mandatory age where money must be taken out.
- Money removed before 59.5 years old will have a 10% penalty and a tax on the earnings.
- The current maximum contribution is $5,500 a year unless over 50 year of age, then there is the $1,000 catch up to also contribute.
Annual modified adjusted gross income is a limit to the use of Roth IRAs.
- In 2017, as a married/joint filer the modified adjusted gross income needs to be below $186,000 ($118,000 for single filers).
- If married/joint income is between $186,000 to $196,000 ($118,000 and $133,00 for single filers) you can make partial contributions.
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If income is more than $196,000 for married filers ($133,000 for single filers) then technically you can not contribute to a Roth IRA.
- There is a work around for this, however, called a backdoor Roth IRA which has been discussed at length by the White Coat Investor and what I personally do.
When to make contributions and other points
- Contribution can be made for the year up until tax day. For 2016 contributions you have until April 18th, 2017 to make the contribution and claim it on your 2016 taxes. You can also make contributions on the first day of the new year. For 2017 contribution money can go in on January 1st, 2017.
- The tax deductions, if you qualify, are above the line and have nothing to do with whether you standardize or itemize the deductions.
How do you set up an account
Consider going to Vanguard, Fidelity, or some other index fund company and set up an account with them. It is relatively easy with good tutorials on the way. Then pick your index fund or mix of funds as I discussed here.
I hope this has been helpful. Any other thoughts?
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One thing to qualify, the ten percent penalty on Roth withdrawals pre 59 only applies to earnings. You can withdrawal and use contributions whenever. Great summary.
Interesting. Thank you for the clarification.
The power of the internet is to compound our knowledge, which much like compound interest, is a powerful force.
Good explanation on the history and aspects of IRAs. I’m planning on putting the extra $$$ I have accumulated towards the end of the year in the IRA. Hopefully I’ll be able to max out, but we’ll see. I have a 401k already which I am prioritizing now in terms of saving.
That’s a great plan. I also typically end up getting a tax return (don’t take too many deductions on my W2 and my home mortgage interest ends up being a good write off). With that money I first max our IRAs and then try to pay down debt. Thanks for checking out the site!
I know you probably don’t qualify for a traditional IRA, but I recommend this for anyone who is able to do so. Deferring income at the top of your income tax brackets, and later taking money out at the bottom of your income tax brackets is a powerful force which will lead to retirement.
I wrote about our Roth rescue on my blog. Basically, we didn’t have enough money invested in taxable accounts, so we had to rescue our Roth principal in order to invest more in taxable accounts. This strategy did wonders for us and I’ll be retiring soon, shortly after I turn 41.
Thanks for the great article.
41! That is awesome. Congrats and thanks for checking out the post. I am actually going to head over to your site now and read this. Here is the link for others interested.
I definitely don’t qualify for either roth or traditional and so I end up doing the backdoor Roth every year.
Nice summary, DDD. I would add that you can invest in anything you want — you aren’t restricted to you company’s investment options like 401(k)s.
Very well said. I personally am in a VTSAX- Vangaurd’s answer to a S & P fund. I figure it gives me exposure and is in a tax protected vehicle.
I set up an IRA when I got out of college and I’m so glad I did! At the time I had a matching account with my employer, which I then moved to my bank after switching jobs. Even if you only put away a little bit, you should take advantage of an IRA while you’re eligible for it.
That’s great. I was not so bright. Sometimes investing and saving small amounts is much easier than a large chunk. Keep on pinching….