How IRAs can be used in Texas Retirement Planning
It is never too late to start working on your retirement planning. You shouldn’t make the mistake of relying solely on your Social Security benefits to provide for a comfortable retirement. Instead, be proactive and create your comprehensive retirement plan now so that you can truly enjoy your retirement. Individual Retirement Accounts are an easy way to get started IRAs, as they provide a simple way to plan, save and invest in your future.
What is an IRA and how does it work?
An IRA is basically an investment account that comes with many tax advantages. With an IRA you will have a reliable way to save money for your Texas retirement planning. Whether you choose a traditional IRA or Roth IRA, you will not pay taxes on any earnings for that retirement account. Instead, you can reinvest those earnings so that your account can continue to grow. Once you reach retirement age and start making withdrawals from your IRA, your tax obligation will depend on three things: the type of IRA, your present income, and the amount of your withdrawals.
The four different kinds of IRAs
There are four different kinds of IRAs, each with its own benefits. These four IRAs are divided into two basic categories: those that are create by individuals (Traditional IRAs and Roth IRAs) and those that are sponsored by employers (Simplified Employee Pension (SEP) and a Savings Incentive Match Plan for Employees (SIMPLE)). All types of IRAs are “fully vested,” meaning that all contributions and earnings belong to you, including those contributions made by your employer.
IRS imposed Limitations on Contribution Amounts
The IRS has placed limitations on the total amount of annual contributions you can make to your IRA account. These restrictions usually change each year, so it is important to talk to your retirement planning attorney to determine the current limitations being imposed.
How are traditional IRAs and Roth IRAs different?
One difference is that a traditional IRA is funded with “pre-tax” dollars, which means you do not pay any taxes on your contributions or the interest they earn, until you start taking withdrawals during retirement. At that point, each withdrawal is taxed as ordinary income. For example, if you owe 20% tax on your income and you take a withdrawal of $10,000 during the tax year, you will owe $2,000 in federal and state income tax.
How are traditional IRAs and Roth IRAs different?
On the other hand, A Roth IRA is funded with “after-tax” dollars. Although a Roth IRA does not provide any tax benefits relating to contributions, the earnings and withdrawals from Roth IRAs are generally tax free. A primary advantage to a Roth IRA is that not only are your earnings allowed to grow tax-free, but when you retire and take withdrawals, you will not be required to pay income taxes. Essentially, the difference is you avoid taxes when you contribute to the traditional IRA, but you avoid taxes with the Roth IRA when you withdraw money at retirement.
Early withdrawal penalties for IRAs
With any type of IRA, the Internal Revenue Service will charge a penalty for any early distributions or withdrawals. With a traditional IRA, you will be required to pay an additional 10% penalty if you take any distributions before you reach the age of 59½. That is in addition to the income taxes that are imposed.
One benefit of a Roth IRA is that you are allowed to withdraw your original contributions at any time, without penalty. That is because you have already paid income tax on those funds. However, early withdrawals of any of your earnings will be subject to the 10% penalty, in addition to income tax. The Roth IRA has an additional requirement. Along with the age requirement of 59½, the Roth IRA must be established for at least five years before you can begin to withdraw earnings, without penalty.
Employer-sponsored IRAs
An employer that has no more than 100 employees, earning more than $5000 each, can sponsor a SIMPLE IRA for its employees. However, there cannot be any other form of retirement plan available. The maximum contribution to a SEP IRA this year is $53,000. The maximum contribution to a SIMPLE IRA is $12,500, if you are under age 50, and $15,500 if you are older than 50. The employer-sponsored IRAs (SIMPLE and SEP) can also be used by self-employed individuals and small business owners.
Download our FREE estate planning worksheet! If you have questions regarding IRAs, or any other Texas retirement planning needs, please contact The Vermillion Law Firm, LLC for a consultation either online or by calling us toll free at (972) 366-7201.
