I get a lot of clients that come in and often don’t know what an IRA is, or what the difference is between the different types of IRAs. It’s totally understandable, this industry is confusing and there are so many rules that apply. However, it’s my job to know what everything means, when you can use them, and how you can use them. So, I decided I would dedicate this blog post to the topic of IRAs. I am going to keep it general, and will follow up with more post that go into detail on all the different IRAs available.

I’m sure you have heard the term IRA before, or maybe Roth IRA, they are very popular retirement planning tools. The acronym IRA stands for Individual Retirement Arrangement. Many people call them Individual Retirement Accounts, and that’s all it is really; an account where you put funds with the intention of saving those funds for retirement. 

So, why are they important? Well, long gone are the days of pension plans and corporate funded retirement. Yes, plenty of government jobs still offer pensions, but for the majority of people, the responsibility of planning and saving for retirement is on them. In place of these pensions, we now have 401(k)s and IRAs. I will have another post that covers 401(k)s and other similar retirement accounts in more detail, but for now, just know this: A 401(k) is provided by companies and corporations and allows an employer to provide an outlet for retirement savings to their employees. The employee can choose to contribute a portion of their paycheck directly to the 401(k) account, and in many cases, the companies will provide a match of the funds contributed. 

So, since the responsibility now falls on the individual; the government created IRA accounts to provide an incentive for people who do not have 401ks, or choose not to use their 401ks, to save for their future.

These are some of the main types of IRAs:

• Traditional IRA/Rollover IRA
• Roth IRA
• SEP IRA
• SIMPLE IRA
• Inherited IRA

Each of these plans has different rules and apply to different people, like for example, the SEP IRA is used for people who own their business or are self-employed. The most popular and most common IRAs are Traditional/Rollover IRAs and Roth IRAs. I am going to focus on these two for now. 

Traditional/Rollover IRAs:

The traditional and rollover IRAs are essentially the same thing, the only difference is that the rollover IRA usually is funded by another account it came over from (or, rolled over from) a 401(k), another IRA, or some other pre-tax plan. Both of these IRAs are funded with pre-tax dollars, this means you have not paid any taxes on this money yet. 

Pros of an IRA: 

• When you contribute to a Traditional or Rollover IRA, it reduces the amount of income you claim on your taxes, therefor providing a tax benefit for you 
• Anyone can contribute to these IRAs, as long as you had earned income. If you made over $6,000 you may contribute the full $6,000, however, if you made less than $6,000, you may only contribute up to the amount you earned. For example, if you made $5,000 in 2019, you would only be allowed to contribute $5,000. 
• All the growth in these IRAs grow tax-deferred. This provides you an opportunity to let your assets grow over time without worrying about taxes until you withdrawal from the account. Over time, this ends up being a huge benefit. 
• The SECURE Act of 2019 now says you do not need to take your RMD (required minimum distributions) until age 72. Basically, you can let these funds grow, tax-deferred until age 72! 
• You can pass on your IRA accounts directly to your beneficiaries when you pass away. Meaning, if you have a beneficiary listed, the account will go directly to them, they will not need to go through probate- which saves them time and money!

Cons of an IRA:

• Any withdrawals before age 59 1/2 are subject to a 10% penalty. There are exceptions to this rule, such as a first time home purchase or qualifying medical expenses, and a few others, but in general, it is not wise to withdrawal from your IRA before age 59 1/2. Doing so would mean paying that 10% penalty, plus income tax on the funds withdrawn 
• You can only contribute $6,000/year (or $7,000 if you’re over age 50) for 2020*
• You will pay taxes on any funds withdrawn from the account. The idea here though, is that most people hope to be in a lower tax bracket in retirement (ideally when they are pulling from these funds), therefor giving them a tax benefit. However, taxes will always be due on distributions. 
• Depending on your AGI (adjusted gross income), you may not be able to deduct some or all of your annual contributions. 
• Your deduction limits may change if you are covered by a retirement plan at work (like a 401k) 

Overall, the Traditional/Rollover IRAs are great for saving for retirement. However, these accounts are best utilized by those who:

1. Know they will not touch the money until at least age 59 1/2 
2. Are in a higher tax bracket now, but believe they will either be in a lower tax bracket when they make withdrawals, or that taxes overall will be lower by the time they take withdrawals 
3. Meet the annual contribution AGI limits and are able to deduct the contributions. If you want to check if you fall within these limits, you may review it here at the IRS website: https://www.irs.gov/retirement-plans/ira-deduction-limits or you can reach out to me and we can discuss it. 

Roth IRAs:

The Roth IRA is one of my all-time favorite retirement accounts. These accounts allow you to contribute after-tax dollars, meaning, that when you withdrawal from these accounts, you do not pay ANY taxes!! Yes please! 

Pros of Roth IRAs:

• All of the growth in Roth IRAs is tax-free, and since you contribute after-tax dollars, this means that all withdrawals (after age 59 1/2) are 100% tax-free!
• Just like your Traditional IRAs, most withdrawals before age 59 1/2 are subject to the 10% penalty.
• You can, however, withdrawal your contributions (not the growth), penalty free. 
• There are NO RMDS (required minimum distributions).
• Like the Traditional IRA, you can pass on your IRA accounts directly to your beneficiaries when you pass away, bypassing probate.

Cons of Roth IRAs:

• You do have to pay the taxes up front. So, if you are in a really high tax bracket right now, this might not be the best option.
• You cannot deduct contributions to a Roth IRA, since you are contributing after-tax dollars. 
• Just like with the Traditional IRAs, you can only contribute up to $6,000 ($7,000 over age 50) or your total earned income, per year*
• There are income limits on the Roth IRA. If you make over a certain amount of money, you may not be eligible to contribute to a Roth. You can check out those limits here: https://www.irs.gov/retirement-plans/plan-participant-employee/amount-of-roth-ira-contributions-that-you-can-make-for-2020 or, reach out to me and we can discuss. 
• In order to withdrawal the earnings without penalty, you must be at least age 59 1/2 AND have had your account opened for 5 years. 

I am huge fan of Roth IRAs if you are eligible to participate. I generally have a rule that taxes are only going up, and with that mindset, the Roth is a wonderful planning technique. I always advise my young clients to first fund your Roth IRA, then whatever you have left over (over the $6,000) you can invest elsewhere, although this isn’t the case for everyone, so be sure to talk to an advisor about your options. The Roth IRA is perfect for:

1. Young kids/young adults that are in a low tax bracket and have earned income
2. Anyone that feels taxes will go up in the future, or that they will be in a higher tax bracket in retirement
3. Anyone that wants to save for retirement, but also not be so restricted to keeping 100% of the funds in the account until retirement. (You can withdrawal your contribution amount at any time)

*Please note that the maximum contribution for BOTH the Traditional and Roth IRAs is $6,000 total. Meaning, you cannot contribute $6,000 to a Roth AND $6,000 to your Traditional. The total contribution to both accounts cannot exceed the $6,000 (or $7,000 if over age 50). 

Also, please keep in mind that, again, these accounts must be set up on your own, they are not offered through employers. The amount you contribute must be determined and completed on your own as an employer will not help you with this (like they would with a 401k, or other employer sponsored plans). Please remember that there are limits, conditions, and exceptions to both these accounts. Be careful not to over fund either one. 

If you are ever unsure, I am always happy to help guide you, and even get one started for you. You can email us at general@pacfs.com for more info. 



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