can create your own in what is referred to as an individual retirement account , or IRA .
Much like defined contribution plans , IRAs are investment accounts that offer significant tax advantages as you build your retirement funds . While there are different kinds of IRAs , they generally come in two flavors – traditional and Roth . Here are three main differences between the two :
• Eligibility . Unlike a traditional IRA , with a Roth IRA , you must remain below a certain income threshold ( based on tax filing status ) to be eligible . That said , if you earn too much to be eligible to open a Roth IRA , you have the option of opening a traditional IRA and converting to a Roth later .
• Contributions . If your income falls below a specified threshold ( again based on tax filing status ), you obtain an immediate tax break on contributions with a traditional IRA , allowing you to lower your taxable income for the year in which you contribute . Roth IRAs do not offer an upfront tax break .
• Withdrawals . While you can withdraw from a traditional IRA after age 59½ without penalty , you pay current tax rates on the withdrawal , and you are obligated to start making withdrawals at age 72 . With a Roth IRA , withdrawals after age 59½ are tax-free so long as you ’ ve had the account for at least five years , and there are no required minimum distributions .
Whether it ’ s a traditional or a Roth , the major benefits to having an IRA are the same as for defined benefit and contribution plans and health savings accounts – they have the potential to grow over time by accessing the markets and offer significant tax advantages .
Divorce and Widowhood Regardless of whether it ’ s a traditional IRA or a Roth IRA , the rules surrounding the division of these assets after a divorce generally follow each state ’ s community property state rules . If the IRA was opened during the marriage , it is considered marital property , while if the IRA existed before the marriage , only contributions made during the marriage with joint funds are considered marital property . In the event of the death of a spouse , your options will vary depending on such factors as your age , the age of the deceased spouse and if your spouse designated others as co-beneficiaries . Generally your choices are similar to those with a defined contribution plan : You can distribute the assets ( with a penalty ), roll the assets into a different retirement account or decline the assets .
PERSONAL SAVINGS
Personal savings generally aren ’ t considered a main source of retirement funds : With 2020 savings account yields topping out at 0.1 % and money market accounts yielding less than 0.25 %, 21 it ’ s hard to benefit from compounding in those types of accounts , even over long periods of time . Still , there ’ s a role for these types of accounts in retirement .
What savings and money market accounts lack in generating interest , they make up for in accessibility and flexibility . If you have a large , unexpected expense ( such as a tax bill ), tapping your portfolio can raise all kinds of complications . ( Which stock are you going to sell ? What are the tax implications of selling stock ? Does a stock sale impact your broader financial plans ? How long will it take for the transaction to be completed ? What fees will the sale incur ?) A robust personal savings account lets you cover emergency or even day-to-day expenses without necessitating a stock sale . Given the importance of making sure your portfolio lasts , a personal savings account can be especially useful in retirement .
TAX-FREE ACCOUNTS
Most retirement accounts offer certain tax advantages , such as tax deferrals or tax-free distributions , but very few are wholly taxfree . Some 529 education savings accounts can be entirely taxfree , if used as designed : Depending on the laws of your state , you can put money into your 529 plan and take it out without ever paying any state income taxes on that income .
One tax-free account that might be of particular use to anyone considering retirement is the Health Savings Account , or HSA . Investments in an HSA go in tax-free , grow tax-free and – so long as they ’ re used for qualified health expenses – can be withdrawn tax-free . Plus , because the IRS doesn ’ t require you to pay for healthcare expenses in the same year that you incur them , you can pay for your healthcare expenses out of pocket and then reimburse yourself from your HSA contributions years later .
Given the skyrocketing costs of healthcare , an HSA account can be a valuable addition to your retirement financial plans .
Strategies for Maximizing Your IRA
• For both traditional and Roth IRAs , you are limited in how much you can contribute in a given year ( currently $ 6,000 ). Like 401 ( k ) s , though , if you are age 50 or older , you can make an additional “ catch-up ” contribution of $ 1,000 per year .
• While it ’ s not the only reason to consider a Roth IRA over a traditional IRA , longevity is a significant one . The longer you live , the longer you would pay taxes with a traditional IRA – which could make tax-free withdrawals from a Roth IRA especially appealing to women with a long life expectancy .
• Typically , you can fund your IRA only with income you earn . A rare exception to this rule is what ’ s known as a spousal IRA . A spousal IRA is a traditional or Roth IRA in the name of the non-working spouse that the working spouse can contribute to . There are certain eligibility requirements – for example , the married couple has to file their taxes jointly – but it is a strategy that lets married couples essentially double how much they could contribute to their IRAs otherwise .
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