Once you start working, it is wise to start saving some of your money for retirement. One of the most popular investment vehicles is the Individual Retirement Account or IRA. It is a personal account that allows you to contribute your savings toward retirement. Regardless of what company you work for, the account is yours. Once you put money in that account, you can purchase a variety of investment vehicles such as stocks, bonds, exchange-traded funds, and mutual funds. For 2015, the IRS limits your contribution at $5,500 for the year. The contribution limit is increased every few years to keep up with inflation. If you can consistently contribute money to your IRA while investing it in high-quality stocks, you’ll position yourself well for retirement. Remember, one of the tried and true ways to build wealth is to save and invest for the long-run, and a tax-advantaged vehicle such as an IRA is a perfect way to do this. In fact, there is even a way to guarantee up to 50% return on your IRA.
When I first started working, I worked for an employer that didn't have a company-sponsored plan. As a result, I decided to go the IRA route so I could have a plan to take with me regardless of my employer. Nowadays, I recommend the IRA route to family members who are just starting to save for retirement. IRAs are easy to set up, easy to maintain, and allow you to get into the habit of saving early.
There are two main types of IRAs. A Traditional IRA is a pre-tax investment vehicle. In other words, contributions that you make to a traditional IRA lower your taxable income. These contributions come out of your paycheck, which allows you to avoid paying taxes up front on that portion of your income. When you withdraw your retirement savings starting at age 59.5, you’ll have to pay income taxes on the entire portion you withdraw.
A Roth IRA is a post-tax investment vehicle. You contribute money from your paycheck to it after taxes have been taken out. The advantage of the Roth IRA is that when you withdraw your money at retirement age (59.5), you avoid taxes not only on your contribution, but also on all the earnings from those contributions. That’s years of investment returns and compounding that you don’t have to pay your taxes on!
If you withdraw early (before 59.5) from your Traditional IRA or Roth IRA, unless if it falls within certain exceptions, you’ll be assessed a 10% penalty in addition to any taxes you may owe.
There are so many different tax vehicles out there. I’ve created a retirement vehicle map to hopefully help you sort out the landscape.
Please consult your tax professional before making any tax decisions.
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