Planning for retirement is essential for maintaining or growing your future lifestyle. Saving a little extra money each month now could reap significant benefits as you near retirement age. There are many different ways to invest your hard-earned dollars now for future events. An Individual Retirement Account (IRA) is one way to potentially minimize or cease paying taxes on interest income when you begin taking withdrawals when you are 50 or older. Here are five things you should know about your IRA that will maximize your investment.
1. Roth Option
This personal investment option is growing in popularity because it includes tax-free growth and tax-free withdrawals. If you’ve owned your account longer than five years and you’re older than 59 ½, the federal government won’t require you to pay taxes on any money you withdraw each month. Not only that, but there is also no Required Minimum Distribution (RDM).
Other advantages to contributing to a Roth IRA include no age limit for qualified earned income and the ability to pass the IRA on to potential beneficiaries with tax-free withdrawals. The younger you start contributing to your account, the more you’re able to take advantage of compound interest. While you are required to pay taxes now, according to U.S. News, investors pay taxes now to remove future uncertain tax rates later.
2. Traditional IRAs Include Required Withdrawals
The required minimum distributions age recently changed after 2020 new federal modifications. Now, traditional IRAs require you to withdraw money from your retirement account when you reach the age of 72 instead of 71 ½. Your RMD is the minimum distribution you must take from your retirement account to avoid undesirable tax effects. However, the IRS states you can now withdraw more than the minimum amount.
While RMD may sound like an additional hoop to jump through, it actually prevents individuals from abusing IRAs to evade paying required taxes. You can determine your required minimum distribution by dividing your account’s fair market value by your distribution period or life expectancy.
3. Costs Matter
Unfortunately, individual retirement accounts can come with higher fees than those available with 401k options. This is why its vital to consider any fees or extra costs that may limit your individual growth. Some high fee investment options will have similar lower-cost investments. It’s essential to convert investments with high fees to ones with charges of 1% or lower. While a 2% fee may seem insignificant, when spread out over a lifetime, the difference can add up to thousands.
4. Penalty-Free Withdrawals
Generally, IRAs include a 10% penalty for withdrawing distributions before 59 ½. Although, there are exceptions to the rule that will allow you to make early withdrawals. You can use early distributions to pay for medical expenses, not reimbursed by your health insurance. However, they can’t exceed more than 10% of your adjusted gross income. Addtinonly, when you lose your job for longer than 12 weeks, you may be allowed to withdraw funds early without penalty to pay for health insurance for you, your family or dependants. Yet, to qualify for this exemption, you must withdraw funds during the same year you claimed unemployment.
You can also withdraw from your individual retirement account when you buy or build your first home. Yet, you may only take up to $10,000 per individual and $20,000 per couple. The only way you can qualify for this exemption is by not having owned a home before purchasing your permanent residence. It’s also important to keep in mind that if plans for your purchase fall through, you must return funds to your IRA within 120 days to avoid further retributions or penalties.