Saving for retirement might not seem urgent now, but the sooner you start, the better off you’ll be in the long run. An IRA (Individual Retirement Account) can be a great way to grow your savings with tax advantages. But before jumping in, you need to understand the basics to make the right decision.
Choosing the wrong type of IRA or overlooking key details can cost you money or limit your options in the future. Whether you’re just starting to think about retirement or ready to open an account, knowing what to consider first can help you avoid costly mistakes.
To help you out, here are some things you should think about before opening an IRA account.
1. Should I Open a Roth or Traditional IRA?
One of the biggest questions people have is “should I open a Roth or traditional IRA?. Both have tax benefits, but they work differently.
– Roth IRA: You contribute money after taxes, but your withdrawals in retirement are tax-free. This is great if you expect to be in a higher tax bracket later.
– Traditional IRA: You may get a tax deduction now, but you’ll pay taxes on withdrawals in retirement. This option makes sense if you expect to be in a lower tax bracket when you retire.
If you’re unsure which one is better for you, consider your current income, tax rate, and future financial goals. A financial advisor can also help you make the right choice.
2. Eligibility Requirements
Not everyone qualifies for both types of IRAs. There are income limits and contribution rules you need to know.
– Roth IRA: If you earn too much, your ability to contribute phases out. For example, in 2024, single filers earning more than $153,000 can’t contribute to a Roth IRA at all.
– Traditional IRA: Anyone with earned income can contribute, but tax deductions may be limited if you have a workplace retirement plan like a 401(k).
Checking the latest IRS guidelines will help you understand whether you’re eligible and how much you can contribute.
3. Contribution Limits
There’s a cap on how much money you can put into an IRA each year. In 2024, the limit is $7,000 if you’re under 50 and $8,000 if you’re 50 or older.
If you contribute too much, you’ll face a penalty, so it’s important to track your contributions. Also, if you have both a Traditional and a Roth IRA, the limit applies to the combined total—not each account separately.
4. Withdrawal Rules and Penalties
An IRA is meant for retirement savings, so taking money out too early can cost you.
– Traditional IRA: If you withdraw funds before age 59½, you’ll pay a 10% penalty plus income tax.
– Roth IRA: Since you’ve already paid taxes on your contributions, you can withdraw them anytime. However, you must wait until age 59½ to withdraw earnings tax-free.
There are some exceptions, such as using IRA funds for a first-time home purchase or qualified education expenses, but understanding the rules helps you avoid unnecessary penalties.
5. Investment Choices
Opening an IRA isn’t just about picking an account—it’s also about deciding how to invest your money.
Most IRAs let you choose from options like:
– Stocks: Higher risk but potential for higher returns.
– Bonds: Lower risk, but more stable growth.
– Mutual funds & ETFs: Good for diversification with professional management.
Some brokerage firms offer “robo-advisors” that automate investing, while others provide more hands-on control. Think about your risk tolerance and long-term strategy before selecting investments.