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Introduction to IRAs

| November 16, 2016
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In my last blog post I discussed whether Social Security will be around in the future. I concluded that post by referencing some products and services at our disposal to assist with retirement income needs. In this post I'll review some of those options.

The more common form of retirement plan would be the IRA. IRAs have different variations, but the two most common are Traditional and Roth. Each type has its advantages and disadvantages.


Traditional IRA:

Advantage: when contributing to a Traditional IRA all contributions are tax deductible and all capital gains are deferred until withdrawal.

Disadvantage: 100% of your withdrawal will be subject to ordinary income taxes.

There are also some penalties that come along with Traditional IRAs. There is an early withdrawal penalty of 10% of the amount withdrawn for any money withdrawn prior to age 59 1/2. There are exceptions to this rule, however, including first home purchase, death or disability, higher education expenses, among others.

Another penalty associated with Traditional IRAs is a penalty regarding your Required Minimum Distribution or RMD. Beginning April 1 of the year after turning 70 1/2, if you fail to take your RMD or take less than the minimum, you will be penalized 50% of the amount that should have been withdrawn. For example, if your RMD for the year is $5000 and you withdrawn $4000. You will owe a $500 penalty.


Roth IRA:

Advantage: This IRA may be more favorable because all withdrawals from this retirement plan are tax free. There is no RMD.

Disadvantage: The 59 1/2 penalty still applies, along with the same exceptions.

Also included in the Roth IRA is an income limit. This means when an individual or a couple exceeds a level of income, they are no longer eligible to contribute. For 2016, an individual making more than $117,000  or a married couple making more than $184,000 cannot contribute. The maximum contribution amount does change every couple of years.

Both Traditional and Roth IRAs have contribution limits. Currently, you cannot contribute more than $5,500 or $6,500 if you are over 50 years of age. This is a total amount, so  if you have a Traditional and a Roth IRA, you cannot contribute more than $5,500 total to both accounts. The ability to contribute $1,000 more once you reach the age of 50 is called a catch up contribution. This also applies to 401ks and that will be discussed more in my next post. The two most popular of these are the 401k and the SIMPLE IRA, each of which have their unique advantages and disadvantages.

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