That adventurous future you’ve imagined — you know, building a second home, exploring a new continent, or hiking the Grand Canyon — is going to cost money (and possibly more than you might think). Opening an IRA (Individual Retirement Account) is a great way to help you save up for a comfortable retirement and all that comes with that: the once-in-a-lifetime experiences, the rainy days, and everything in between.
But your IRA won’t fund itself, so consider taking these actions to help your retirement savings keep up with your future self.
Know your IRA options.
A number of different types of IRAs exist, so you’ll want to acquaint yourself with each option — and their eligibility requirements and tax advantages — to make sure you’re picking the right one for you. Keep in mind, no matter which kind of IRA you select, you need taxable income to open it.
The two most common IRAs are traditional and Roth. The main difference between the two is how they are taxed. Traditional IRAs allow you to make deposits, or contributions, tax-free. Your money is then subject to the income tax when you withdraw, or take distributions, during retirement. Contributions to Roth IRAs are made with after-tax dollars, so you pay tax now and withdrawals during retirement are tax-free.
If your employer offers a 401(k) plan, you may still consider opening an IRA as an additional retirement savings option for added flexibility. IRAs offer certain benefits that 401(k)s don’t — for instance, certain early withdrawals (meaning, before age 59 ½) from an IRA won’t incur the additional 10% early withdrawal tax.
Examples of qualified early distributions from IRAs include some higher education expenses and up to $10,000 for first-time homebuyers. And due to updates in the SECURE (Setting Every Community Up for Retirement Enhancement) Act, withdrawals of up to $5,000 are permitted for expenses related to childbirth and adoption for up to one year from the date of birth or legal adoption finalization. See more early distribution exceptions here.
Re-energize your balance.
Once you have opened the best IRA for your financial goals, it’s time to deposit some money in your account. After all, each year you don’t contribute to your IRA, retirement income is lost.
A deposit to your IRA is known as a contribution. The sooner you begin building a balance in your retirement account, the more time to grow its earning power.
You can fund most IRAs with a check or a transfer from a bank account — and that option is as simple as it sounds.
You can also put existing retirement funds into your IRA. Moving funds from any type of retirement account to an IRA is called a transfer, a rollover, or a conversion. The basic difference is this: a transfer occurs between accounts of similar type (for example, moving funds from an IRA at one institution to an IRA at another); a rollover occurs between different account types (for example, moving funds from a 401(k) to a traditional or Roth IRA). A conversion occurs when you move funds from a traditional IRA to a Roth IRA.
The main thing to remember about both rollovers and transfers is that any existing retirement funds should go directly into the IRA without making any pit stops in your other accounts. That way, you avoid paying unnecessary taxes on those amounts.
Play by the rules.
The last thing you want is to be penalized for not knowing IRS contribution rules. As previously mentioned, one hard and fast rule to remember: You must have earned income to open and contribute to any IRA. The rest of the rules governing federal limits on annual maximum contribution amounts are based on your income, age, IRA type, filing status, and other factors.
Beginning in 2020, thanks to the SECURE Act, certain contribution rules have changed. One of the biggest changes? The age limit for contributions to traditional IRAs (previously 70 ½ years) no longer applies.
You can contribute to more than one IRA in the same year, but the total amount can’t exceed the annual limit set by the IRS. The most common IRA contribution guidelines for 2020 include:
If you’re contributing to a Roth IRA, see the current income limits that affect how much you can contribute.
You should also be aware of the rules that govern IRAs upon the death of the owner. That’s because changes included in the SECURE Act have affected beneficiaries as well. Prior to the SECURE Act, non-spouse beneficiaries could “stretch” required minimum distributions (RMDs) from an inherited IRA for many years, potentially allowing the money to grow tax-free over their lifetime.
Now, in most circumstances, beneficiaries must make a full payout of distributions within 10 years of the death of the account owner — which may affect how you designate beneficiaries and overall estate planning.
It’s a good idea to consult with a tax professional familiar with your situation and visit the Internal Revenue Service website for specific, up-to-date information.
Make — and stick to — a plan for regular contributions.
Whether you see your future self on a tour bus, on a humanitarian mission, or in your backyard garden, you’ll want to come up with a solid plan to help you get there.
One way to make sure you’re contributing regularly is to use the power of automation. Consider setting up automatic transfers from your checking or savings account to your IRA on a schedule that works for you — maybe biweekly or once a month.
Another way to set and forget contributions is through direct deposits. Talk to your employer about depositing a portion of your paycheck directly into your IRA, so you’ll never have to worry about cash making it into your account. Plus, if you don’t see the money in your checking account, you won’t miss it when it’s time to move it to your retirement account.
Of course, in general you will only get the maximum tax benefit from making the maximum annual contribution to your IRA, but only you can determine what amount is realistic for you. Most experts will tell you that making regular contributions gives you your best chance at long-term success.
While it may not be top of mind 24/7, you don’t want to let your IRA fall by the wayside. Try to schedule regular check-ins (possibly quarterly) to keep an eye on your account and stay on track with your contributions. That way, you’ll have a good idea whether you need to give your funding a boost or if you’re in good standing. So, no matter what you see yourself doing in the future, you can be sure your IRA will keep up.
Don’t have an IRA yet? Visit our IRA basics to see if opening one makes sense for you.