10 Reasons to Consider Contributing to an IRA
If you are planning for retirement, consider contributing to an IRA. Here are some of the benefits that can come from setting up an IRA as well as the positive features that you may notice once you start to use it.
1 – You Have Different IRA Options: Traditional IRAs and Roth IRAs
There are two main types of IRAs:
- Traditional IRAs
- Roth IRAs
With both types of accounts, the maximum amount that you can contribute for 2016 is the lesser of:
- Your compensation received from working
- $5,500 ($6,500 if age 50 or over): Anyone with sufficient compensation can contribute to a traditional IRA. With Roth IRAs, there are some income-based and other limits, but many people have the option to contribute.
It may also be possible to contribute to both a traditional and Roth IRA, though a single contribution limit applies.
2 – You Can Lower Your Taxes Now or Lower Your Taxes Later
The most notable difference between traditional and Roth IRAs is the tax treatment of contributions:
Most people who set up a traditional IRA can deduct their contributions. The IRA deduction can lower your taxable income, thus reducing taxes owed. You can claim this deduction even if you use a standard deduction (versus itemizing). If you have a traditional IRA, and you deducted all prior contributions, distributions received will be fully taxable.
For some, a portion or all of your traditional IRA contributions are nondeductible.
If you or your spouse are already covered by a retirement plan at work, the IRA deduction may be reduced or eliminated once your income exceeds certain thresholds.
Roth IRA contributions are not deductible. However, in most cases all distributions you take from the account at retirement will be nontaxable. This feature makes Roth IRAs a good planning device for receiving tax-free income at retirement and may be appealing for people who believe they will be paying more taxes in later years.
3 – You Get Asset Growth Without Paying Tax on that Growth Each Year
With both traditional and Roth IRAs, the income generated is not taxed until distributions take place. In other words, these assets can grow over time without appearing on your return. This ability to grow assets also allows for the opportunity to yield a greater IRA balance by the time you decide to retire. You will likely need to report and pay tax on earnings distributed from a traditional IRA, but not with most Roth IRA distributions received after age 59½.
4 – You Will Supplement Your Other Savings
IRAs are designed for individuals, and they can augment other retirement programs offered by your employer (such as a 401(k) plan). IRA contributions will not impact your ability to defer income into an employer-sponsored plan. If you participate in an employer-sponsored retirement plan, your ability to deduct a traditional IRA contribution may be reduced or eliminated.
5 – You May Be Able to Receive a Tax Credit
Traditional and Roth IRA contributions are “eligible contributions” when figuring a credit called the Retirement Savings Contribution Credit, or Saver’s Credit. The credit will reduce the taxes owed, if it is available. The maximum credit is $2,000, but it is reduced and eventually eliminated depending on your income and filing status.
6 – You Can Withdraw Assets Before Retirement
If you find that you need the IRA funds prior to retirement, you can access them. However, if you are under age 59 ½ and receive a distribution, you will likely need to pay a 10% additional tax on top of the normal income tax liability associated with the distribution. There are some exceptions to this rule. For instance, if you need the funds to purchase your first home, you can take a one-time withdrawal of up to $10,000 without paying the 10% tax.
7 – You Can Contribute for a Spouse
Normally, if you do not earn compensation during the year, you can’t contribute to an IRA. But, for married couples with only one working spouse, there is an exception to the rule. A working spouse can establish a “spousal IRA” on behalf of the non-working spouse in addition to their own account. In 2016, this means that a working spouse with sufficient compensation can contribute up to a combined $11,000 to the two accounts if both spouses are under age 50.
8 – You Can Contribute After the End of the Year
You have few options to change your prior year tax liability once you begin your tax return preparation.
With an IRA, though, prior year contributions can be made up until the return filing deadline. Therefore, a 2016 IRA contribution can occur as late as April 18, 2017. Taxpayers who can claim an IRA deduction and the Savers Credit can reduce their tax liability or increase their refund, while others may choose to set one up to get a start on retirement saving.
9 – You Can Use Your Tax Refund to fund an IRA
The IRS will allow you to file a tax return claiming a tax deduction for an IRA contribution before the money is in the IRA account as long as you make the contribution by tax deadline. Be sure to designate the tax year for which the contribution is being made in writing, otherwise the IRA Custodian may consider it reportable for the calendar year in which it is made.
10 – There’s No Minimum Age Limit for Opening One Imposed by the IRS
Anyone with compensation can contribute to an IRA, including dependents and individuals who do not file a return. A teenager with a part-time job can contribute to an IRA up the lesser of the two limits mentioned about in the same manner of a 45-year-old accountant. It is never too early to start planning for retirement with an IRA!
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