Individual Retirement Account

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What is an Individual Retirement Account (IRA)?

Individual retirement accounts (IRAs) are tax-deferred investment accounts helping families save for retirement. The three main types of accounts are Traditional IRA, Roth IRA, and Rollover IRA, and all provide tax benefits that provide greater long-term incentives to investing, rather than standard investment accounts with no such features. One can open an IRA account at most banks, robo-advisor services, and online brokers.

Different types of IRA

Traditional IRA

With a traditional IRA (Individual Retirement Account), contributions are made with funds one could potentially deduct on one’s tax return. For example, contributing $1,000 to a traditional IRA account could reduce the amount of one’s taxable income by $1,000. Earnings can grow tax-deferred until one withdraws them for retirement. Retirees often find themselves in a lower tax bracket once they have retired, so the tax-deferral means the money will most likely be taxed at a lower rate, allowing retirees to take in more of their earnings than they might otherwise have had with another investment account.

Contribution limits for traditional IRAs in 2022 are stated to be $6,000 per year; however, account holders over the age of 50 can contribute up to $7,000 per year.

Some additional rules may apply to your circumstances. In a marriage, if you or your partner has a retirement plan at work, the amount you are allowed to deduct from your traditional IRA contribution is reduced or eliminated altogether once you hit a certain income. One would still be allowed to make contributions, but they would not be tax-deductible. If you and your spouse are not provided retirement plans at work, then you could deduct your IRA contribution no matter income status.

What is a Roth IRA ?

With a Roth IRA, one makes contributions with after-tax funds. This means they are not tax-deductible, which is the main differentiator from the traditional IRA. This way, as long as all conditions are met, earnings can grow tax-free, with tax-free withdrawals in retirement as long as all conditions are met. This is an attractive option recommended to young investors who are in a low tax bracket.

The contribution limit for Roth IRAs in 2022 is $6,000 per year; however, account holders over the age of 50 are able to contribute up to $7,000 per year, just like with the traditional IRA. However, if one earns over $144,000 per year or $214,000 as a married couple, then their yearly contribution could be reduced or taken away entirely.

What is Rollover IRA?

In a Rollover IRA, one contributes money “rolled over” from a qualified retirement plan into a traditional IRA. Rollovers involve moving investments from an employer-sponsored plan, such as a 401(k) retirement plan, into an IRA.

What are the major objectives of the IRA?

IRA accounts are simple and great investment accounts to help achieve your retirement goals. For most people, the desired goal of their long-term investment can be earning growth over time and to provide their family with an additional income stream during retirement while also minimizing the impact on their taxes. To determine your retirement goals, you can make a list of general, specific, and investment goals you expect to achieve before retirement. These goals can help you and your partner stay on track.

General goals should be positive and lighthearted. Include broad goals such as future dreams, how you plan to live out your retirement and where, and inheritance plans for your heirs. Specific goals should consist of goals that have a specific timeframe for completion. It is essential to review these goals periodically and to compare them with where you are currently. Lastly, investment goals should include your investment strategy. If you and your spouse are young, you can have a more aggressive investment strategy, but as you get closer to retirement, switching over to conservative investments is the best option.

Why is the IRA so important?

A 401(k) or pension may not provide enough retirement income to live comfortably. Putting the maximum contribution amount in an IRA can help one prepare for retirement, save on taxes, and gain access to investment options an employee retirement plan might not offer.

If one’s employee retirement plan does not provide an employer matching policy, if the employer matching policy is low, or if it has limited investment options or high fees, it could be a better option to primarily invest with an IRA account to receive greater tax-free benefits.

If you have an older 401(k) account, you can move it into a rollover IRA account to fully maximize its tax-free and tax-deferred benefits without triggering any fees.

What are the advantages of IRA?

Around 33% of employees in the private sector do not have an employer-sponsored retirement plan like a 401(k). Without such a plan, many employees do not end up saving for their retirement; however, a personalized IRA can be an extremely convenient way to prepare for those golden years.

Not only do IRA accounts act as retirement savings vehicles, but they can also be used in some notable exceptions, like educational expenses or first-time home purchases. However, it is fundamental to understand that in most cases, if funds are withdrawn before the age of 59 ½, there will likely be an early withdrawal penalty of 10%. If the IRA account is a traditional one rather than a Roth IRA account, one may owe income tax on their early withdrawal as one would typically have paid that tax at retirement and at a lower tax bracket.

IRA accounts are some of the easiest and accessible forms of investment account you can open. Most banks and online brokerage accounts can help you open one in just minutes. To open an account or make contributions to a traditional IRA, you or your spouse need to earn taxable income. There’s also no age limit for opening or contributing to a Roth IRA, but your ability to contribute may be reduced based on your tax filing status and the amount of your modified adjusted gross income.

Another benefit to an IRA account is that you can personally manage your investments on your own, work with a financial advisor, or even automate your investments. The options are endless on how you want to begin and maintain your investments and what level of help or guidance you want along the way.

Why you should consider IRA

Choosing an IRA account allows account holders to experience tax benefits on their savings, thus allowing all money earned on the account to grow and compound quicker than in a standard taxable account.

Financial experts estimate that one may need up to 85% of one’s pre-retirement income for retirement. An employer-sponsored retirement savings plan, such as a 401(k), is often not enough to accumulate the savings one may need to retire.

Fortunately, one can contribute to both a 401(k) and an IRA account, allowing account holders to supplement their current savings plan with their employer-sponsored retirement plan. This also helps gain access to a wider range of investment choices than what could be provided with your employer-sponsored plan while also taking advantage of potential tax-deferred or tax-free growth. Options like stocks, bonds, exchange-traded funds (ETFs), and mutual funds are all on the table to choose from.

This way, if possible, one could attempt to maximize the contribution to their IRA account and to their employer-sponsored plan each year to get the most out of these savings options.

How Arrowroot Family Office can help you with IRA?

If an IRA account sounds like the right investment account for you, Arrowroot Family Office can help you begin your investment journey. Arrowroot Family Office understands that creating a comprehensive retirement plan is challenging for many people. As a result, Arrowroot Family Office specializes in helping individuals achieve financial independence so they can enjoy their retirement and fulfill their retirement goals. Arrowroot Family Office uses different retirement plans tailored to different needs and goals depending on each financial situation. Thus, Arrowroot Family Office can help individuals become confident in their retirement and prepare for any unforeseen events.

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Frequently asked questions

An IRA, or an individual retirement account, allows account holders to save money for retirement in a tax-advantaged way. An IRA allows an individual to save for retirement with tax-free growth or on a tax-deferred basis, allowing its holders to save money on their yearly taxes while also investing for their retirement.
They are not the same. A 401(k) is a type of employer retirement account, while an IRA is an individual retirement account. 401(k) can provide employer matching benefits, while IRAs are known for their pre-tax and tax-deferment benefits.
IRAs can be a fantastic investment opportunity to save on your yearly taxes. This option is especially great for employers who do not have an employee matching investment plan like a 401(k) or for employees who are able to max out their yearly 401(k) contribution and are looking for more ways to invest. An IRA also gives you more investment choices than a 401(k) or an employer-sponsored retirement plan.
Typically, IRAs see average annual returns of 7-10%. However, depending on your investment strategy, this number may be higher or lower.
Savings accounts are ideal for short to medium-term savings, perfect for emergency funds or short-term savings goals. However, savings accounts return low yields. On the other hand, IRAs are better for long-term savings intended for use during retirement.
401(k) is considered to be more secure than IRAs in the event of a bankruptcy or an adverse lawsuit. However, a spouse may still be able to receive those funds after those events.
If possible, it is important to maximize both your 401(k) and your IRA. Depending on how high your employer matching policy is, it would make sense to maximize one over the other. If your employer does not have an employer matching policy, then it would be best to just strictly invest with an IRA account to enjoy all of the tax benefits.
Your traditional IRA contributions may be tax-deductible. However, the deduction may be limited if you or your spouse is covered by an employee retirement plan or if income exceeds certain levels.
Money in an IRA can be withdrawn early to pay for tuition and other qualified higher education expenses without a penalty. To avoid paying a 10% early withdrawal penalty, the IRS requires proof that the student is attending an eligible institution. Qualified education expenses include tuition, fees, books, supplies, and equipment required for enrollment or attendance.
Yes, you can roll over an IRA into 401(k) if the 401(k) provider will allow it. The easiest way to roll an IRA into a 401(k) is to request a direct transfer, which moves the money from your IRA into your 401(k).

The IRS will charge you a 6% penalty tax on the excess amount for each year in which you don’t take action to correct the error. If you contributed $1,000 more than you were allowed, you’d owe $60 each year until you correct the mistake.