It takes dedication to save for retirement. Most folks don't have tens of thousands of extra dollars hanging around to invest in the stock market. And if we did, we might be nervous about the outcome. Investing in the stock market is like gambling. Even if you're quite good at it, you can still lose a lot of money. That’s where Traditional Individual Retirement Accounts (IRAs) come into play.
The bottom line is that you still need to save for retirement.
IRAs offer a way for Americans to save money towards retirement and get tax breaks on that money right now. With this article, we'll explain how Traditional IRAs work.
Before we get any farther, know that Traditional IRAs are:
- Available at any bank or credit union
- Guaranteed (you won't lose your money in the stock market)
- Paying much better interest than a savings account
And best of all, they require very minimal investments. Many financial institutions will let you start one with just $100 (though they may charge a small maintenance fee until you get your savings up to $1,000.)
But what exactly is an IRA?
An IRA is a retirement savings account that allows folks to save for retirement with tax-free growth or on a tax-deferred basis. There are three different types, each with distinct advantages.
Traditional IRAs allow us to save money on a tax-deferred basis. In other words, you won't pay income taxes on the money you save now, but you will pay taxes on it later when you retire and pull the money out. There is a $5,000 yearly contribution limit allowed by the IRS.
There are several ways IRAs can benefit you financially right now:
- Lower-income families get tax credits ranging from 10% to 50% of their investment. That's immediate money back on your income tax return.
- No matter what tax bracket you're in, you'll have a lower taxable income this year (though again, you'll pay taxes on this money later when you retrieve it.)
- If you're only into a higher tax bracket by a few thousand dollars, IRA investments can bump you back down to a lower bracket, which can make a huge difference come tax time.
The other types of IRAs include ROTH and Rollover IRAs. ROTH IRAs are more like traditional savings accounts. You'll save after-tax dollars, and you won't see any tax benefits by using them. Employers provide rollover IRAs in the form of a 401(k) or 403(b).
Leave IRA Funds Alone Until You're Ready to Retire
You can pull Traditional IRA funds out of the bank if there's an emergency, but you'll pay taxes on it this year. These funds are considered income paid, so they could bump you up into the next tax bracket if you're not careful.
- Once you're retired, you must start drawing the funds and paying taxes on them.
- However, most people are in a lower tax bracket after retirement.
We did some math to see just how valuable IRAs can be for your retirement.
We Did the Math: Retirement Savings Add Up in a Traditional IRA
From $1,000 a year to higher amounts, we tallied up your potential retirement savings here:
- If you start saving $1,000 a year ($83.00 a month) in a Traditional IRA at age 40, you'll have more than $25,000 in savings at age 65.
- If you're 50 and save the full $5,000 per year, you'll have more than $75,000 saved to retire at 65.
Both those examples are before interest. In reality, you'll save even more! Remember, this is money you won't pay taxes on until you're ready to withdraw the funds. You'll enjoy a lower taxable income this year.