Don't know how to save money for retirement? Watch IRAs!

How are you going to cover your expenses when you retire? Although your main source of income disappears, you’ll have the continual round of bills for utilities, fuel and food to pay. Of course, some companies provide a retirement pension, but this practice is becoming less common. As a result, everyone has to consider retirement saving. 

There are several options available to people who want to save money for retirement. In addition to 401k or 403b plans, you should think about investing in an IRA. These retirement accounts are used by millions of Americans. Just lay aside a certain amount each month and, instead of spending it, deposit it into a retirement account. Your IRA can mean big bucks when you become older!

An individual retirement account, or IRA for short, is an effective savings tool. It provides tax advantages and a wide range of investment options, including stocks, bonds and mutual funds. Tax deferral can significantly fatten your savings over time. However, there can be some penalties if you don’t use your IRA for its intended purpose. 

Advantages and disadvantages of IRAs

IRA’s main benefit is tax-deferred growth. The US government wants people to save money for retirement. The more investments you have in your retirement account, the less likely you will depend on Social Security. With that in mind, they give significant tax benefits to IRA accounts. Your earnings will not be taxed each year, so you can reinvest them for more returns. 

Another potential benefit is the ability to deduct contributions from your taxable income. It allows you to pay taxes on less money in the current year. However, keep in mind that not all IRAs have this feature. 

As with all things in life, IRAs have some disadvantages that you should know about. This type of accounts is intended for retirement saving. So you shouldn’t cash the money out until you reach “retirement age” determined by the IRS. If you take your assets out of an IRA before that age, you may have to pay a 10% penalty and, in some cases, income tax on the amount you withdraw. 

Another pitfall is that there are certain limits on how much you can contribute to a retirement account. The IRS could lose a lot of money if people put their total income away and didn’t pay taxes on it. That’s why you can contribute up to a set amount. 

For the 2008 and 2009 tax years the limit for IRA contributions is $5,000 (if you are over 50, $6,000). If you have several retirement accounts, you also can’t put more than $5,000 into your Roth and traditional IRA combined ($6,000 for individuals aged 50 or more).

Investment options 

Do you think that you can only invest in certificates of deposit within an IRA? Actually, there are more investment options. For example, you can invest your money in mutual funds, bonds or stocks. However, this option can be risky. 

Banks usually offer CDs as the main product of IRAs. The rates are low, but your money will be safe because CDs are FDIC-insured. On the other hand, with lower long-term returns your deposit is subject to inflation. Just ask your granny how much things cost when she was young to get an idea of inflation’s effect!

If you are going to invest your money in stocks or mutual funds, you have to know what you’re getting into. Although you will have a higher rate of return, take into consideration that you might lose your money! With the recent collapse of major banks and the stock market decline, you will definitely want to choose more secure investment options. 

Types of IRAs

As an educated consumer looking to get the best deal (that is you, right?), you need to understand IRAs before opening one. There are a several different types of retirement accounts, which may be either employer-provided or self-provided. 

•    Traditional IRA
This plan lets you make contributions to your retirement account with pretax dollars. So you can use a traditional IRA to lower your taxable income, and thus reduce the amount of money you have to pay in taxes. However, your withdrawals at retirement are taxed as income. You can start cash the money out at the age of 59 ½. Any early withdrawals are subject to penalty. 

•    Roth IRA
Roth retirement account is named for its legislative sponsor, Senator William Roth. In this plan the contributions are made with after tax dollars. It means that Roth IRAs do not lower you taxable income. What’s their advantage? Your earnings and withdrawals are tax-free. It means that you won’t need to pay taxes on this money when you retire (if you hold the account for at least 5 years and you are over 59 ½ years old).  

•    SEP IRA 
It is a plan that allows an employer (typically a small business or self-employed individual) to make contributions into a traditional IRA opened in the employee's name instead of to a pension fund account established in the company's name.

•    SIMPLE IRA
This plan works similar to a 401k plan. Both employer and employee can make contributions, but there are lower contribution limits. 

Which IRA to choose?

You may be wondering which IRA is the best match for you. This choice needs to be made with careful thought and consideration. With a traditional IRA, your money will be taxed at a lower rate. However, you will be making less money once you have retired. With a Roth IRA you will pay taxes on a smaller amount of money because you will need to pay money only on your contributions and not on your earnings. 

Although funds can be distributed from an IRA at any time, there are limited circumstances when it can be done without penalties. Unless an exception applies, you can withdraw money penalty-free from a traditional IRA once you reach age 59 ½. Withdraws begin at age 70 ½ are mandatory. 

Roth account owners have no mandatory distribution age (subject to some conditions). You can leave your funds in the account if you do not want to take them out. However, this type of retirement accounts is available only to single-filers making up to $95,000 or married couples making a combined maximum of $150,000 annually.

Where can I open an IRA?

If you want to open an IRA, you can choose either a bank or an investing firm. Banks may have an investing branch that you can go through as well. An IRA can only be funded with cash or cash equivalents. It is not allowed to transfer any other type of asset into the individual retirement accounts.  

If you decide to change types of IRAs, it is better to open a new one and leave your current account alone. Otherwise, there could be tax penalties involved if you switch between different types of IRAs. Some financial institutions can charge fees for switching accounts to another company.