An Individual Retirement Account, also known as an IRA, is a type of brokerage account that allows individuals to save and invest for retirement with a unique tax advantage. An IRA is a powerful way to save money, which is why many financial advisors encourage their clients to use them. Here’s what you need to know about an IRA and how to use it to save money to pay for senior care during retirement.
Why should I open an IRA?
Opening an IRA is a powerful way to help save money and fund senior care expenses during retirement. The benefit of saving with an IRA is twofold: Contributors get a break on their taxes, and they’re also encouraged to set money aside for their retirement. This makes contributing to an IRA a win for those who qualify.
Roth vs. Traditional IRAs
There are two types of IRAs: the Roth IRA and the Traditional IRA. The Roth IRA allows you to contribute post-tax income and enjoy tax-free growth. You pay taxes on your income upfront, but you won’t have to pay taxes on any of the interest or capital gains you receive on your investments.
A Traditional IRA allows people to contribute pre-tax income and benefit from deferring their tax burden. With a Traditional IRA, you get a tax write-off for contributions up front, and you don’t have to worry about paying taxes on your investment gains until you begin to withdraw money in retirement.
Which type of IRA is right for me?
Generally speaking, when picking an IRA, you need to take a step back and consider the trajectory of your income throughout your life because you want to pay as little income tax as possible.
If you expect your income to increase between now and retirement, a Roth IRA is probably a good fit. That’s because as time goes on and your income increases, so will your tax liability. So, paying your taxes now makes the most sense.
On the other hand, if you expect your income in retirement to be less than when you are working, it’s best to pay your income taxes in retirement. By that time, you will be in a lower tax bracket, meaning less of your income goes toward paying taxes.
It’s important to note that projecting your income in retirement isn’t as easy as it sounds. People often overstate the money they think they’ll make in retirement. Like any major financial decision, you should consult a trusted financial advisor before opening an account. They will work with you to ensure you’re opening the proper account and making suitable investments.
Pros and cons of using an IRA
While IRAs are great savings tools, they still have both benefits and drawbacks. Although they are investment vehicles, there are a few things you should know about them before making contributions to them. We’ve outlined the most prominent pros and cons of using an IRA.
- IRAs give you a tax-advantaged way to save for retirement.
- You can contribute up to $6,000 ($7,000 for those 50 and older) per year to your IRA.
- Funds withdrawn from an IRA after age 59.5 can be used for anything, such as long-term care or other senior living expenses.
- IRAs have income caps. So, if you make more than $144,000 (single filers) or $214,000 (married filing jointly), you cannot directly contribute to an IRA.
- Accessing the money you’ve contributed to your IRA can be difficult if you’re younger than 59.5 years old.
- The contribution caps might not be high enough, especially if you’ve started saving later in life.
When can you withdraw funds from an IRA?
You cannot withdraw the funds from an IRA whenever you want. While there are specific rules for both Roth and Traditional IRAs, you generally will not be able to withdraw from an IRA without penalty before age 59.5.
If you need to withdraw before 59.5, consult with a tax professional, as you may be able to avoid paying the penalty if you’re using the money for the following:
- A first-time home purchase.
- Educational expenses.
- Death or disability.
- Medical expenses.
- Birth or adoption expenses.
- Health insurance.
After you turn 59.5, you can withdraw your IRA as much as you want without penalty.
Below, we’ve outlined the specific withdrawal rules for both Traditional and Roth IRAs:
If you make a non-exempt withdrawal before age 59.5 from a traditional IDA, you must pay income tax and a 10% penalty on the money you withdraw.
You must also take an annual required minimum distribution (RMD) every year after you turn 72. The IRS calculates the amount of your RMD, so consult your tax professional when the time comes around.
With Roth IRAs, there are no RMDs, which is convenient if you don’t need the money and would like to pass it on to your heirs.
The penalties for withdrawing money before 59.5 are slightly less harsh than a Traditional IRA. With a Roth IRA, you only have to pay the 10% penalty, as income tax has already been paid before making your contribution.
Are IRAs worth it?
Overall, IRAs are an effective way to save for retirement. They are a great investment vehicle that makes sense for many people. As you contribute to this type of savings plan, you’ll save money for your senior care needs during your retirement. Before opening an IRA, consult with a trusted financial advisor because opening the right type of account is key.