After recently purchasing our house, a fixer upper, I know now the struggle… the struggle to want everything done and finished. No more projects no more planning on projects for the house. I know this isn’t realistic, as that day is a long way off. It will be some time before our fixer upper is in a good spot, at least what my wife and I consider a good spot.
Just like with a fixer upper, saving for retirement is not a one shot game. We should be constantly saving, constantly finding ways to tax-efficiently use our resources for that day. It won’t take one good year of earnings, but being consistent.
One of the best ways to do this is by opening and funding an IRA or ROTH IRA.
But which one makes the most sense and why is it a good idea?
Firstly, an IRA is an individual retirement account. This is separate from a company 401(k) or company 403(b). Everyone has the option to open and contribute to an IRA as long as you or your spouse had taxable earned income for the year. Whether the IRA contribution is deductible or not depends on the total income you had for the year. So what is an IRA?
As an individual retirement account, this account will allow you to make pre-tax contributions so that the money grows tax deferred inside this account. Then when you are over 59.5 you have the option of taking the money back out. At that time it would become taxable to you, based on your tax bracket at that time.
The limit for 2015 is $5,500 with an extra $1,000 allowable if you are over 50.5, also called a catch up.
Why would this be a good idea?
If you are in a relatively high tax bracket you can shelter income from taxes now, if you are expected to be in a lower tax bracket in retirement.
For example if you made $100,000 and are in the 25% tax bracket but made a $5,500 IRA contribution you would owe taxes on the $94,500 instead of the $100,000. This $5,500 would then grow tax deferred, so any interest or dividends earned by investing within the account would be tax deferred.
If that sounds appealing, then consider instead a Roth IRA. For a Roth IRA you can contribute after tax money and let it grow tax – free. Then in retirement or after age 59.5 you could withdraw the money penalty and tax free! This type of account makes sense if you are in a lower tax bracket now, or are young. The idea being as you make more your tax bracket will be increased and it may not make much sense to contribute after tax money, but instead get the deduction of making a IRA contribution.
Last but not least, consider diversifying account types. Being in retirement having a Roth IRA and IRA from which to withdraw from allows you to lessen required minimum distributions and avoid withdrawing income if you don’t need it. This would be a great way to continue to delay tax if you need or want to.
Everyone has the option to do a “backdoor Roth” which is doing a non-deductible IRA contribution and converting it to a Roth IRA. So, if you think you can’t do a Roth contribution, think again!
Over time by making plenty of IRA or Roth IRA contributions your road to retirement becomes nicer and feels complete. Diversifying account types is a good idea and using different tax strategies for your specific situation is the best way to be sure your goals are met.
If you haven’t filed your taxes yet, you still have time to make the above type of contributions.
Need help setting up an IRA or Roth IRA, or potentially a better retirement strategy, lets discuss in a strategy session.