An IRA, either in its traditional form or as a Roth, gives you the opportunity to reduce your taxes and grow your wealth for the future. The deadline for 2014 IRA contributions this year is April 15, and the maximum contribution amount is $5,500. If you are fifty years old or older, you can contribute another $1,000 annually as a catch-up contribution. However, many people do not understand the differences between IRAs or what other opportunities exist that can help you with your retirement wealth.
Traditional v. Roth IRAs
There are two main types of IRA accounts. The first is a traditional IRA, where earnings can grow tax deferred until you reach age 70½ years old. However, if you make withdrawals before age 59½, you may incur both ordinary income taxes and a ten percent penalty. As soon as you reach 70½ years old, you are required to start taking the minimum required distributions (MRDs) and start paying taxes on that amount.
A Roth IRA contribution is not tax deductible the year that you make it, but the money in the account can grow tax-free. In addition, the withdrawals are tax-free in retirement as long as certain conditions are met. Contributions to a Roth IRA are subject to income limits and early withdrawal penalties. However, Roth IRAs do not have MRDs like traditional IRAs.
One final option is a spousal IRA. This type of account allows a spouse that does not earn wages to contribute to their own traditional or Roth IRA. However, the other spouse must be working, and the couple must file a joint tax return. Eligible married couples can each contribute up to $5,500 for the 2014 tax year to their respective IRA, and spousal IRAs are also eligible for a $1,000 catch-up contribution.
Opening an IRA for Family
If your children or grandchildren are working and earn a taxable income, you can gift them their annual contribution to an IRA. Up to $5,500 can be deducted from your annual gift amount of $14,000 without repercussions with gift taxes. However, a contribution cannot exceed the amount that your child or grandchild earns in the year if it is lower than the contribution maximum amount.
Investing Your IRA Contribution
Many people forget about making an IRA contribution until right before the deadline of April 15, and they simply put it into a money market account. However, they do not ever think to go back and place that money in an investment. This situation is not ideal because the best way to grow an IRA is to invest in a mixture of stocks, bonds, and mutual funds. If you do not feel skilled enough as an investor, there are other options available.
You can consider a target fund date, where a manager selects, monitors, and adjusts the mix to match a target retirement date. Another good option to consider is a managed account, where the managed account provider determines an asset mix based on your financial circumstances, time horizon, risk tolerance, and investment goals. A skilled financial advisor can set up either option for your IRA account.