What Is an IRA and Why Do I Need One?

Derek Notman |

Millennials & gen-z’ers who are wanting to invest and save for the future (like their retirement) should consider a great savings tool called the IRA.

IRA's for millennials

What is an IRA?

IRA’s are a powerful resource in helping you reach your retirement savings goals. Given the different types of IRA’s that exist it is understandable that choosing the right one can be quite tricky at first, but they aren't as complicated as they may seem.

So, let's take a look at what precisely an IRA is, why you may need one, and how you can get started with one.

An IRA is designed to help you build wealth for retirement. There are 5 types of IRA accounts; a Roth IRA, a Traditional IRA, a Rollover IRA, a SEP IRA, and a SIMPLE IRA. The differences? Contribution rules, eligible owners and tax treatment.  The SEP IRA and SIMPLE IRA are employer sponsored so we will not be diving into those in this article.

With IRA's, you can save for retirement with on a tax-deferred basis by either paying taxes now or later.

Here are the three main types of IRAs which all have different advantages:

  • Roth IRA 

With this type of IRA, individuals make contributions with money they have already paid taxes on - this is done after-tax. The advantage? Well, your money has the potential to grow tax-deferred AND can grow tax-free. You will need to make sure all rules are followed to ensure you maximize the benefits of a Roth IRA, which will result in entirely tax-free withdrawals at some point in the future.

  • Rollover IRA 

This type of IRA is a little different. Perhaps you are familiar with the various types of retirement accounts you can have gotten from your employer, like a 401(k) or the 403(b).  Well, when you leave or retire from an old job you can take your retirement account with you and roll it over into a Rollover IRA.  This can be into a Traditional or Roth IRA depending on how you were set up with your retirement account at work.

  • Traditional IRA 

Lastly, the traditional IRA. All contributions to this IRA are made from the money you are able to deduct on your tax return now, thus avoiding having to pay taxes on those earnings now. Earnings from this IRA will grow tax-deferred until you retire but will be completely subject to income taxes in the future although they may be taxed at a lower rate when you are retirement if your income tax bracket drops.

The advantage? When the time comes for you to retire, you will most likely be in a lower tax bracket. This means your money will be taxed at a lower rate.

When it comes to withdrawing money from these accounts, you have to wait until the age of 59 1/2 before you are able to withdraw your investment returns without facing an early-withdrawal penalty.  Although there are certain rules that allow for early withdrawals.

One of the exceptions is to withdraw up to $10,000 for a down payment on your first home.

In summary, with an IRA, you can:

  • Enhance your current savings if you have an employer-sponsored retirement plan
  • Have access to a more comprehensive range of investment choices than your employer-sponsored plan
  • Benefit from potential tax-deferred or tax-free growth
  • Maintain complete control of your money regardless of where you work or if you are retired.
Retirement on the beach

How do you open an IRA? 

Firstly, you have to ask yourself the following question: What kind of investor are you? Hands-on or hands-off? The answer to this question should determine whether you go with a bank or an online financial advisor.  You should also make sure to work with a financial advisor to figure out which type of IRA is right for you and how it fits in with the rest of your financial life.

Opening the actual IRA account takes only a few minutes but building wealth through an IRA is where expertise is required. 

An online financial advisor can help you figure all of this out and how/where to set up an IRA as part of your overall savings strategy.

Now that you have an overview of what IRAs are and how they work, you may be wondering which one is right for you?  Well that is a personal decision that should be based upon your unique situation.  With that said I do love the Roth IRA and have put together a comprehensive Roth IRA Guide (Free E-Book) that you can access below.

To use a Roth IRA to its full potential, you will need to understand the following:

  • What are the Roth IRA contribution & income limits?
  • What are the Roth IRA Withdrawal Rules?
  • What is a Roth IRA Conversion?
  • What is a Backdoor Roth IRA?
  • What is the Roth IRA Pro-Rata Rule?
  • What is a Roth 401k?
  • Roth IRAs for kids: Can I open a Roth IRA for my child?

Now to worry, we have a free eBook called "The Comprehensive Roth IRA Guide for Your Money In 2019" which covers all the above. It will help you get started, but as mentioned previously, consider collaborating with an online financial advisor/wealth manager to build wealth properly. 

As always thanks for reading!

Cheers,

Derek

 

*When considering rolling over the proceeds of your retirement plan to another tax-qualified option, such as an IRA, please note that you may have the option of leaving the funds in your existing plan or transferring them into a new employer’s plan. You may wish to consult with your new employer, if any, to learn more about the options available to you under your plan and any applicable fees and expenses. You may owe taxes if you withdraw funds from the plan. Please consult a tax advisor before withdrawing funds.