Having an IRA is one of the smartest retirement saving strategies. With this account, you get a lot of tax benefits which allow you to grow your retirement savings fast. If you already have an employer-sponsored account such as a 401(K), you are well on your way to boosting your wealth. But, a 401(k) is not enough to maximize your retirement savings. To supplement your 401(k), open an IRA as there are many benefits of IRA that 401(k) plans do not offer.
If you need to know the benefits of IRAs and why you should open an IRA today, keep reading.
What is an IRA?
IRA stands for an individual retirement account that comes with tax benefits. You can open an IRA from your local bank, credit union, or investment firm such as a brokerage firm. There are two major types of IRAs. The first one is a traditional IRA where your contributions might be tax deductible but you will pay tax on your withdrawals during retirement.
The second type of IRA is a Roth IRA where your contributions come from after-tax wages. With a Roth IRA, you grow your account tax-free and pay no income tax on your withdrawals.
For 2024, the contribution limits to an IRA are $7,000. If you are 50 or older, you can contribute an extra $1,000 catch-up contribution. For 2023, you can contribute up to $6,500 or $7,500 if you are 50 or older.
Each IRA comes with its benefits which you can leverage to maximize your retirement savings. This article will cover the benefits of IRA that you should know.
What are the benefits of an IRA?
When I first opened an IRA, I did not know what to expect or why it was important to have one. Over time, I realized that having an IRA was one of the best financial decisions I ever made.
If you are skeptical about opening an IRA, the following are the benefits of an IRA to help you decide.
1. IRAs are easy to set up and manage
One of the biggest benefits of an IRA is that they are very easy to set up and manage. You will also have full control of your retirement savings and investment choices.
You can open an IRA with your bank or from brokerage institutions. Another benefit of an IRA is that there are many providers which gives you an option to bargain for lower rates.
2. IRAs give you tax benefits
Another benefit of IRA you will enjoy is the tax benefits. Like any other retirement plan, tax savings is an integral part of retirement savings. By paying less tax or delaying taxes, you can invest your money and grow your account much faster.
A traditional IRA lowers your taxable income by making before-tax contributions. You also grow your account on a tax-deferred basis but pay tax during retirement.
The Roth IRA, on the other hand, requires after-tax money but you grow your account tax-free and you do not pay tax on your withdrawals.
Related: Traditional IRA vs Roth IRA: What is the difference?
3. IRA can reduce your taxable income
Many people think that taking home all their wages improves their finances. The reality is that realizing all your income makes your financial situation worse as you end up paying maximum taxes and lose the ability to save for retirement and invest in your future. One way to legally pay less tax is to contribute to an IRA.
By opening a traditional IRA, your contributions to the account will be fully or partially deductible which will reduce your taxable income. According to the IRS, the deductible amount on your IRA will depend on your income, filing status, and other tax-advantaged benefits you have from work.
Related: What is Individual Retirement Account(IRA): A complete guide
4. An IRA comes with a wider range of investments
One of the most important benefits of an IRA is that it comes with a wide range of investments. Unlike 401(K) plans where you are limited to pre-selected investments inside your plan; IRAs offer a great range of investments.
When you open an IRA, you get access to popular investment options such as mutual funds, ETFs, stocks, bonds, etc. These investment options can help you grow the account faster compared to 401(K).
5. You are in control of your account
what makes IRAs great retirement saving strategies is that you are in control of your account. You can make adjustments to your account as you wish which could involve buying and selling investments as necessary. With a 401(K) or 403(B), however, you are stuck with investment options that come with the account and cannot buy or sell investments outside of your account.
6. IRAs come with fewer fees
When it comes to growing your retirement account, every dollar counts. Without lowering your fees, you could end up losing a large chunk of your retirement earnings in fees which could easily be in hundreds of thousands of dollars especially when you hold actively managed funds.
Since your IRA account can be opened, set up, and managed by you; you can make a lot of decisions as to how much you can pay in fees. You can shop around and open an IRA with a provider with lower fees. IRAs also come with lower fees compared to 401(k) plan fees.
7. An IRA will help you move money from a 401(k) plan to an IRA without paying taxes
Retirement savings accounts come with a lot of regulations. A common retirement rule that costs thousands of dollars to millions of people is the age requirement before taking withdrawals.
Most retirement accounts require that you reach 59.5 years old before you can withdraw money from your retirement savings without a penalty. For example, if you withdraw money from your 401(K) before you reach 59 1/2, you will pay a 10% penalty and tax on your distributions.
What if you quit your job and don’t want to cash out of your 401(K)? How can you move money from your former employer without paying taxes? A simple answer is to use a Rollover IRA to move money from your old 401(k) into an IRA.
By using a Rollover IRA, you can avoid paying a 10% penalty and tax on the money you moved.
Related post: What happens to your 401(K) when you quit your job?
8. Benefits of an IRA: Tax-free wealth transfer
One of the biggest difficulties in wealth protection is how to transfer wealth to your descendants without paying taxes.
Your heirs could end up paying a lot of money in taxes if the will is not transferred correctly. That is why opening the right retirement account helps you avoid taxes when transferring wealth to your descendants. For example, your Roth IRA account can be given to your descendants tax-free.
What are the disadvantages of an IRA?
While there are many benefits of an IRA, the account also comes with disadvantages that you should know. The following are IRA drawbacks you should know.
1. Limited contribution amount
The IRS sets limits on how much you can contribute to an IRA each year. This can restrict the growth of your retirement savings, especially if you’re starting late. For 2024, you can contribute up to $7,000 if you are under 50 and $8,000 if you are 50 or older.
2. Early withdrawal penalties
If you need to withdraw money from your IRA before reaching 59 1/2, you’ll typically face a 10% early withdrawal penalty in addition to applicable income taxes. This penalty can significantly reduce your savings.
3. Required Minimum Distributions
Once you reach age 73, you must start taking required minimum distributions (RMDs) from your traditional IRA, whether you need the money or not. Failure to do so results in a hefty tax penalty.
4. No loan provision
Unlike 401(k) accounts, IRAs do not offer loan provisions. If you need money for a financial emergency, you may have to face the penalty for early withdrawal.
5. Tax deduction limitations
Your ability to deduct your traditional IRA contributions on your tax return may be limited if you or your spouse are covered by a retirement plan at work, and your income exceeds certain levels.
6. No employer match
Unlike a 401(k), IRAs don’t have the added benefit of employer matching contributions. This means all the contributions are made solely by you.
What are the contribution limits to an IRA in 2024?
The contribution limits to an IRA depend on various factors such as your income, filing status, and the type of IRA you have- Roth IRA or traditional IRA. For 2024, the Internal Revenue Service (IRS) sets the limit at $7,000 for those under 50 and $8,000 for those 50 or older. However, these limits are subject to change and can be adjusted every year to reflect changes in the cost of living.
Does your money grow in an IRA?
Yes, your money does grow in an Individual Retirement Account (IRA). An IRA allows you to invest in a tax-advantaged way. The purpose of an IRA is to help you grow your retirement savings through investments. Depending on the type of IRA you choose, your savings can grow either tax-deferred or tax-free. The investments you choose will determine the rate at which your money grows. Some common types of investments you can choose include stocks, bonds, and mutual funds. If managed wisely and with proper investment strategies, your money can significantly grow over time in an IRA.
