The financial aspect of planning for retirement can be daunting. Between managing investments, budgeting income and expenses, and configuring savings accounts, there’s a lot to keep track of. And unfortunately, when it comes to retirement, the stakes are high: failure to correctly prepare for your economic needs can turn a would-be idyllic retirement into a financial catastrophe.
With these things in mind, many people have turned to IRAs (individual retirement accounts) for structure and security in their retirement savings. On a broad level, IRAs are accounts that are specifically intended to hold retirement investments and allow the account holder to make tax-deferred contributions.
Within the wider category of IRAs, however, a variety of options exist. Choosing the type of IRA that best suits your needs is important, and may require some research or the input of a financial advisor. Here, we’ll go over a brief description of how IRAs work, their benefits and drawbacks, and an outline of some of the more common types.
IRAs: The Basics
Basically, IRAs allow the contributor to be strategic about the way they pay taxes on the money they have set aside for retirement. For some people, it may be advisable to defer taxes on their retirement savings (a traditional IRA), while others may prefer to pay those taxes upfront (a Roth IRA).
IRAs can be established at most financial institutions, including banks, credit unions, and investment firms. Different institutions may have different policies and practices, so it’s a good idea to shop around. As you decide between different institutions, here are a few questions to consider:
- How involved do you want to be in managing your IRA? For example, if you’re deeply invested (pun intended) in managing your finances, you may be better off looking for someplace that affords clients a high degree of control and autonomy and has a digital interface that’s easy to use. Alternatively, if you prefer a hands-off approach, it could be helpful to find an institution or advisor who understands your goals and is willing to take care of the legwork for you.
- What sorts of investment options are you looking for?
- Will your account be subject to any fees or charges (either recurring or one-time)?
Pros and Cons
In addition to their flexibility when it comes to taxes, another perk of IRAs is that they allow for a wider array of options when it comes to investing the money within the account (as compared to other types of accounts like 401(k)s). These options include stocks, bonds, mutual funds, and more. For this reason, IRAs also offer a high degree of personalization based on your tolerance for risk and your preferences around asset allocation.
Since IRAs are specifically intended to be used for retirement investments, there are some restrictions around the way they can be used. These include annual contribution limits, withdrawal rules, and potential penalties or taxes if you withdraw money before the age of 59 ½.
Traditional IRAs versus Roth IRAs
In the majority of cases, choosing between a traditional and a Roth IRA will depend on two things: income and anticipated tax status.
Traditional IRAs allow you to deduct your IRA contributions from your taxes in the year that the contribution is made. However, when you withdraw that money later, the withdrawal is subject to taxes. So, if you anticipate that you might end up in a lower tax bracket post-retirement, a traditional IRA may be a better fit for you, because you are effectively deferring your taxes on that money.
Roth IRAs, on the other hand, essentially allow you to pay taxes on your retirement money upfront. Although your contributions to a Roth IRA won’t be tax-deductible, later withdrawals are eligible to be tax-free (assuming they meet the IRS qualifications). Moreover, any interest accrued by the funds in your Roth IRA won’t be subject to taxes either. Roth IRAs are recommended for people who are likely to end up in a higher tax bracket post-retirement. One thing to keep in mind is that in order to qualify for a Roth IRA in the first place, your modified adjusted gross income has to be below a certain threshold.
Although traditional and Roth IRAs are the most well-known and commonly used types of IRAs, there are several others, such as SEPs, SIMPLE IRA plans, and Gold IRAs.
Gold IRAs are an increasingly popular option for IRA investment. A Gold IRA involves gold or other precious metals being held for the benefit of the IRA account owner instead of the traditional paper assets. Investing in a Gold IRA offers a tax-efficient, stable way to diversify your assets while also protecting them. This option often presents favorable and steady rewards, further benefiting an IRA’s balance of risk and return. You can find out more about Gold IRAs here.
Resources such as the IRS website can be helpful places to find out more about all of the various types of IRAs and how they work.
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