Money Smarts Blog
What’s an IRA and Why Should I Care?
Mar 5, 2019 || Elizabeth VanCamp
Up until a few months ago, I didn’t understand the importance of saving for retirement. I realized I’m about halfway to retirement and I—like 21% of Americans—had nothing saved for my grand dream of retiring on the beach in San Diego.
This is a much bigger problem than I had thought, especially since most financial experts suggest having an entire year’s salary saved for retirement by your thirtieth birthday.
I’ve spent my twenties with the mentality that I have plenty of time before retirement, so why worry about it? In doing this disservice to myself, I avoided learning about any kind of retirement savings strategies or accounts. So, when I realized how behind I was a few months ago, I researched the best ways to get myself caught up, and that’s when I learned about IRAs.
In short, IRAs are retirement accounts you contribute to after you receive your paycheck (so the contributions are post-tax) and you should definitely care about them. Let’s dive more into the details.
An IRA is an individual retirement plan which you can contribute to with post-tax dollars, that’s not associated with your employer (an employer-offered retirement plan is called a 401(k)). Since your contributions have already been taxed, all future withdrawals from this fund are tax-free.
You can choose to contribute to a traditional IRA or a Roth IRA, both of which have certain tax benefits. For traditional IRAs, your contributions are tax-deductible the year you make them, and for Roth IRAs, your withdrawals are tax-free during retirement.
One of the best things about opening an IRA is that there’s no minimum you have to put into your account. You can put as little as you want or can afford into it, and you’re still going to reap some great benefits!
However, there are maximum amounts you can contribute per year to your IRA. In 2019, most people can contribute up to $6,000 to their IRA, and people over 50 can contribute up to $7,000. The increased amount after 50 helps people catch up and get closer to where they’d like their retirement savings to be.
Should I choose an IRA or 401(k)?
Luckily for you (and me, and everyone else who is trying to save for that beachfront retirement!), you don’t have to choose between a 401(k) and an IRA. In fact, utilizing both types of retirement savings accounts can provide you with maximized returns and reduced risk.
If your employer offers a 401(k), you should definitely take advantage of it. There are a couple things to consider:
- If your employer matches 401(k) contributions, start making contributions to yours ASAP. This is FREE money. Don’t walk away from it. You can also contribute to an IRA, but it’s not a must.
- If your employer doesn’t offer a match, start contributing to an IRA. Then, when you’ve maxed out your IRA contributions for the year, begin adding to your 401(k). IRAs give you more investing options and you may be eligible for tax deductions on your contributions this year.
Another thing to be aware of – you can contribute a max amount of $19,000 to a 401(k) in 2019. So, in comparison to the $6,000 IRA limit, it might seem enticing to focus solely on maxing out your 401(k) contributions. But it’s important to know whether your employer will match any contributions and know the difference in rate of return between your 401(k) and an IRA. If you find that your 401(k) will truly offer the best return on investment, go nuts contributing to that account!
How hard is it to start an IRA?
I’m here to give you the good news that it’s not difficult at all!
You can start an IRA with your financial institution or with an investment company. Then you’ll need to decide what kind of investor you want to be: independent (you manage your investments yourself) or hands-off (you allow a financial advisor to handle your investment decisions).
Personally, I want someone else to manage my IRA because I don’t have the time or energy to devote to it, but you may be up for the challenge. There’s no wrong choice here, it’s just your personal preference.
IRAs offer you the chance to save for your future, even if you can’t afford to put a lot of money away each month. So, take a look at your budget and figure out where you can spare some money to invest in your IRA. Look at it as treating yourself—but instead of treating yourself to something short-lived now, you’re treating yourself to a future with financial stability, which will make for much happier golden years.