People want answers on retirement planning more than ever. With pensions becoming a thing of the past, people look to IRAs and 401(k)s as their solution. I’ll never recommend a single account as your solution for retirement, but IRAs will play a big part for most people. It’s undeniable how valuable they are and how much they can offer you over the long haul. With that said, let’s dive right into how to make the most of your IRA!
What Is An IRA?
An IRA is a type of tax-advantaged investment account. There is a cap on how much you can contribute annually for Roth IRAs, for which there is also an income limit.
I’ll go over the two types shortly, but you may only have a traditional IRA available to you depending on your income. That being said, both are valuable and a good investment, so don’t fret if your hit the Roth IRA income or contribution limit!
Traditional
In a traditional IRA, your contributions are deducted from your taxable income. Like the traditional 401(k), this means your contributions are made essentially tax-free, however you will have to pay tax when you withdraw from them during retirement. This can be a good thing since a lot of people will be in a lower bracket when they retire. However, it is always unknown how policies and taxes will change in the future, so you can never be completely sure which will end up being the better option in the long run.
Roth
Roth IRAs use contributions that have already been taxed. While that seems unfortunate now, it does mean you won’t have to pay taxes on them later on, which could turn out in your favor (but it could also work against you too). The main issue for Roth IRAs is that they have an income cap, so once you make over a certain amount you can’t contribute to it anymore.
Some people like to do a combination of Roth and traditional IRAs, but it is more common to just focus on maxing out a Roth IRA. While IRAs, like 401(k)s, have a minimum age of 59.5 years old before you can withdrawal with no penalties, there are a few exceptions if you need them – but it’s best to avoid early withdrawals altogether.
Find A Great Brokerage
You’ll need to find your own brokerage for an IRA. Fortunately for all of us, there are several great ones out there. Vanguard is a classic and quite good in its own right. Fidelity is another great option. For ease of use, with its pie-building interface, M1 Finance is another undoubtedly great pick.
Start Early And Invest Consistently
The earlier you start investing, the better off you’ll be in the long run. It’s best if you start early and stay consistent. Keep investing more as your salary increases, and try not to skip any investments. In fact, if you can then you should automate it (most brokerages should let you do that). It isn’t hard to beat the “experts” – it just takes time and discipline.
Maximize Your Tax Breaks
One of the nice things about the traditional IRAs is that it lowers your current taxable income. If you find yourself in a very high tax bracket, it may be best to put the money that is taxed at the highest rate into the IRA, or as much of it as you can afford to. Of course, that’s just a suggestion and what you find you’ll need to do may vary. Just be on the lookout for ways you can use your IRA to your advantage with your taxes. It’s a tax-advantaged retirement account after all, saving more of your money from taxes is part of the point.
In the case of the Roth IRA, you don’t have to pay taxes on your money when you withdraw. This can be nice, especially for assets that can be rough on the taxes. For example, REIT income is usually subject to hefty taxes, but with a Roth IRA you can potentially avoid that.
Diversify With Different Types Of IRAs
As I mentioned earlier, there are two types of IRAs you can use in combination to hedge your bets to various degrees. I can’t recommend the perfect combination of the types of 401(k)s and IRAs since so much depends on your personal situation. However, I can say that as long as you are consistently investing, you’re doing better than many. As far as traditional vs Roth goes, it’s usually an easy choice – most people default to Roth and prefer that over the traditional.
A common tactic I see is to have a traditional 401(k) with a Roth IRA, or vice versa. People who really like to hedge their bets may have a traditional 401(k), a Roth 401(k), a traditional IRA, and a Roth IRA. Do what makes you feel comfortable, and don’t be afraid to contact and advisor for help. If you’ve reached the income limit for Roth IRAs, then your decision is much easier.
Never Withdraw Money Until You Have To – Or Reach Retirement Age
You should avoid withdrawing money from your IRA until you reach retirement age (i.e. 59.5). If you withdraw money prematurely, you may or may not be subjected to penalties.. Therein likes the drawback of using these retirement accounts. In my opinion, that is perfectly fine. That just means you need to plan your strategy around not being able to use this money until you’re approaching 60. If you really think you’ll want to withdraw early, the Roth IRA makes that easier – you can potentially withdraw the funds you contributed (but not the gains) without a penalty.
Required Minimum Distributions
Once you reach 72, you may be subject to requirements on how much you withdraw. If you fail to take out the minimum, there will be a significant penalty on the remainder. This is unfortunate, but not a deal-breaker by any means. Simply, once you reach 72, make sure you’re withdrawing the minimum amount required to not get hit with those penalties!
Invest In Low-Fee Index Funds And ETFs
The best thing people generally usually invest in with their IRAs are low-fee index funds and ETFs. What funds you have access to may vary based on what the employer offers. You can see my guide on investing in index funds and ETFs for more details. Unfortunately, because what funds your plan offers will vary, you’ll really have to do the legwork on your own or consult with an advisor.
The main thing you’ll need to be wary of is the fees. A lot of the time, when you ask the company managing the IRA for help, they’ll recommend the investments with the highest fees. When you’re researching, take note of their fees as well as their overall long-term performance. Pick carefully – those fees can add up!
Diversify
It’s also important to diversify. I can understand finding a specific investment or index fund you love, but try to diversify your investments. Diversity will strengthen your finances and make them more secure over the long run.
Max Out Your IRA
If you’ve taken everything so far to heart, but you still want to get more out of your IRA, then max it out! Hitting the maximum on your IRA is a great and straightforward shot to setting yourself up for a successful retirement. It’s expensive, but the more you put in now, the better off you’ll be later. Besides, it’s certainly an attainable goal!
Put Money In Your Spouse’s IRA Too
The maximum contributions on Roth IRAs can be pretty limiting, but that maximum is doubled when you’re married. Make sure you’re taking advantage of both of your Roth IRAs if possible. Additionally, it’s important to keep communicating about money with your significant other. Also, if one of you stays at home and doesn’t have a job, you should still be saving money for their retirement!
Have A Beneficiary
Lastly, make sure you have a beneficiary for your IRA. This goes with estate planning in general, but make sure you have your ducks in a row with these things. It’s unpleasant to think about, but it’s especially important to consider with your financial assets (especially ones intended for use in your later years). Setting a beneficiary can make sure there is a smooth transition and your loved one is taken care of after you’re gone.
Conclusion
Hopefully this gave you what you needed to start making the most of your IRA. If you have any tips of your own, let us know in the comments. For more content like this, and a free budgeting template and financial goals worksheet, be sure to sign up for the Bitter to Richer newsletter.
