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How an IRA Can Help You Prepare for Retirement

By David McAlpine, Peoples Bank Wealth Management Group Officer
3/24/2022

The average American will spend 20 years in retirement, but only about half of workers know how much money they need to save for their golden years. In this article, we’ll explain what an Individual Retirement Account (IRA) is, and how contributing to an IRA can help you plan for retirement.

Photo: Man, woman, and dog by the water
Text: An IRA allows people to build tax deferred retirement savings.

What is an Individual Retirement Account (IRA)?

An IRA is a tax-advantaged personal savings plan. There are two types of IRAs that can be set up by an individual:

  • Traditional IRA: Contributions may be tax-deductible, which depends on certain income requirements and on whether you or your spouse is an active participant in a qualified retirement plan.
  • Roth IRA: Contributions are not tax-deductible, but you can enjoy tax-free distributions in retirement*.  There are certain income limitations to make a Roth IRA contribution.

What are the Pros and Cons of having an IRA?

IRAs are a great retirement savings account option for almost anyone. Whether you also have a workplace-sponsored retirement account or not, an IRA could be an important part of your retirement savings plan. The benefits of having an IRA include:

  • Tax benefits: With a traditional IRA, you may be able to reduce your overall taxable income. With a Roth, your savings and growth are tax-free in retirement*.
  • Compounding growth: The growth and earnings you experience on your IRA contributions becomes part of the balance and compounds which helps you grow your savings faster.
  • Flexibility: There are exceptions to the penalty for early withdrawals, including for educational expenses and a first-time home purchase. Also in a Roth IRA, you can withdraw your contributions anytime without taxes or penalties.
  • Choice: Choose from a variety of investment options for your IRA, including mutual funds, stocks, bonds, ETFs, and fixed or variable rate CDs.

Keep in mind that, while there are no income limits for contributing to a Traditional IRA, there are income limits on Roth IRAs. Single tax filers with a modified adjusted gross income (MAGI) of less than $129,000 can make a full contribution in 2022. Those who are married and filing jointly must have MAGI of less than $204,000 to make a full contribution in 2022. 

Also, once you open an IRA, you should plan to leave it untouched until at least age 59½. Otherwise, you could face tax penalties for early withdrawals (aside from a few exceptions).


IRA Contribution Limits in 2022

Photo: Notebook and calculator
Text: In 2022, there is also a $6,000 / year contribution limit for IRAs 
(an additional $1,000 catch-up contribution is allowed for those 50 and older).

Know the maximum annual contribution limits on Traditional and Roth IRAs, which is the smaller of:

  • $6,000 (an additional $1,000 catch-up contribution can be made for individuals 50 and older)
  • Your taxable compensation for the year


Traditional IRAs vs Roth IRAs

Now that you understand the basics of IRAs, let’s compare the similarities and differences between Roth and Traditional IRAs.


Who can contribute?

If you or your spouse have taxable income for the year, you can contribute to a Traditional or Roth IRA. There are no longer any age limits. For Traditional IRAs, there are income limitations to receive a tax deduction when you or your spouse are active participants in a retirement plan.  For Roth IRAs, there are income limitations to be eligible to contribute regardless of whether you are an active participant in a retirement plan or not.


Are contributions tax-deductible?

For Traditional IRAs, contributions may be tax deductible, but contributions to a Roth IRA are not tax deductible.


How much can I contribute?

The annual contribution limit is the same for both Traditional and Roth IRAs. It is a combined limit, which means the total is determined based on annual contributions to your Traditional and Roth IRA.  If you are married, your spouse would also be able to contribute up to their own annual limit.


What is the annual contribution deadline?

Photo: Calendar
Text: The deadline to max out your IRA contributions is always the tax filing deadline. So, you can make 2021 contributions until April 15th, 2022, for example.

The deadline to max out your IRA contributions is always the tax filing deadline. So, you can make 2021 contributions until April 15th, 2022, for example.  This can be helpful if you are trying to determine whether a Traditional or Roth IRA contribution would be the most beneficial to you from a tax perspective.


When can I withdraw money from my IRA?

Technically, you can withdraw money anytime. However, tax penalties may apply if you make withdrawals before age 59½, unless certain exceptions apply. In a Roth IRA, you can withdraw your contributions anytime without taxes or penalties; however, any growth on those contributions would be subject to taxes and penalties until you have had a Roth IRA for 5 years and are 59½.


Are minimum distributions required?

With a traditional IRA, you must start taking distributions by April 1 following the year in which you turn age 72. There are no required minimum distributions from a Roth IRA. There are different distribution requirements for beneficiaries of Traditional and Roth IRAs when they inherit the IRA.


Are my withdrawals and distributions taxable?

Yes, for withdrawals from Traditional IRAs and no for qualified distributions from Roth IRAs. Qualified distributions from a Roth IRA occur after your Roth IRA has been open for five years and you are over 59½.

So, how do you decide which type of IRA is right for you? Well, you can always open both types. Check out our Roth IRA Calculator and Traditional IRA Calculator to test different scenarios.


What Are Rollover IRAs?

Most people no longer stay with the same employer for their entire career. So, what happens to your 401(k) balance when you switch jobs? Rollover IRAs allow people with employer-sponsored retirement accounts to transfer those funds into a tax-deferred IRA account. There is no limit to the amount of funds that can be transferred this way, and rollover IRAs also help you avoid certain IRA penalties and delay any tax consequences that would be associated with taking a distribution.


Can Retirees Contribute to an IRA?

Yes, you can contribute to an IRA if you are retired. There are no longer age limits on contributing to IRAs as long as you’re still making taxable income, though with a traditional IRA you’ll also have to begin minimum distributions at age 72. Of course, the earlier you start saving for retirement, the more time your funds will have to grow. So wherever you are in life now is a great time to open and start funding an IRA account.

Photo: Man working at a desk
Text: Contact Peoples Bank Wealth Management Group to discuss your IRA options today.

How to Open an IRA Account

Contact Peoples Bank Wealth Management Group or use the Quick Contact form to learn more about IRAs.  Peoples Bank Wealth Management Group has the knowledge and experience to work with you to reach your financial goals.


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*Tax-free distributions in retirement from a Roth IRA occur after you have had a Roth IRA account open for 5 years and you are over the age of 59 ½.

 

Peoples Bank Wealth Management Group does not provide legal or tax advice.  Please consult with your legal or tax advisor in regards to your individual situation.  Investments involve risk including the possible loss of principal.  Investment products are not FDIC insured, not a bank deposit, not guaranteed by the bank or any U.S. Government Agency and principal may lose value. 

 

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