An IRA is a great way to save toward a secure financial future, but you may be wondering how they work. Here are answers to 10 frequently asked questions.
1. What's an IRA?
An IRA is an individual retirement account, also called an individual retirement arrangement. It provides tax advantages to encourage individuals to save for retirement.
2. What's the difference between an IRA and a 401(k)?
As the name implies, an IRA is opened by an individual. A 401(k) is an employer-sponsored retirement plan, which is opened through an employer. Other examples of employer-sponsored plans are 403(b)s, 457s and thrift savings plans (TSPs).
3. Is there more than one kind of IRA?
There are 2 basic types:
- A traditional IRA is tax-deferred. That means you don’t have to pay tax on any interest or other gains until you start withdrawing the money at retirement (generally, no earlier than age 59½). At that time, distributions are taxed at ordinary income tax rates.1
- Contributions to a Roth IRA are taxed as ordinary income, but withdrawals are tax-free, provided you meet certain conditions, such as holding the account for at least 5 years and being at least age 59½ when you start distributions.1
There’s also something called a Simplified Employee Pension (SEP) plan, a retirement plan for the self-employed and employees of participating companies. However, the rules and contribution limits are different. Learn more about SEP IRAs here.
4. Should I open a traditional or Roth IRA?
It depends. If you’re eligible to deduct your contribution, a traditional IRA may be a good choice—especially if you think you’ll be in a lower tax bracket when you retire. Your IRA contribution is fully tax-deductible, up to the annual limit, if neither you nor your spouse has a retirement plan at work. If either of you has a retirement plan at work, deductibility is limited by income. Learn more on the IRS website.
Roth IRA contributions are never tax-deductible. However, if you’ve held the account for 5 years and are at least age 59½ when you start distributions, your withdrawals in retirement will be tax-free. A Roth may be a better choice if you aren’t eligible to deduct your contribution or if you’d prefer to have tax-free income in retirement.
5. Who can open and contribute to an IRA?
Anyone with earned income and his or her spouse can open and contribute to a traditional IRA (though tax deductibility depends on income).
Anyone with earned income under a certain limit, and his or her spouse, can open and contribute to a Roth IRA; there’s no age restriction.
6. How much can I contribute to an IRA?
The annual contribution limit is $6,000 or your earned income, whichever is less. This amount is indexed to inflation each year. Those ages 50 and older may make an additional $1,000 catch-up contribution or up to a total contribution of $7,000.
7. Can I have a traditional and a Roth IRA?
Yes, but the annual contribution limit applies to the total of all IRAs you own, not each IRA individually. For example, if you contribute the maximum amount to your traditional IRA, you won’t be able to contribute to your Roth IRA in that year.
8. Do I have to start taking money out of my IRA at a certain age?
With a traditional IRA, you must start required minimum distributions (RMDs) at age 722 or face a tax penalty.3 With a Roth IRA, you don’t have to make RMDs during your lifetime.
9. What's a rollover IRA?
A rollover IRA is an account set up to accept transferred funds from another IRA or an employer-sponsored retirement plan. Rollover IRAs aren’t bound to the annual contribution limit for IRAs. Any amount can be rolled over as long as it comes from an eligible plan (such as a 401(k), 403(b), 457 or TSP) or another IRA. A rollover IRA can be an excellent way to maintain tax advantages of retirement savings after you leave your job.
Starting in 2015, you may roll over an IRA to another IRA only once each year, regardless of how many IRAs you own. Direct and indirect transfers from employer plans to IRAs aren’t limited.
10. Why open an IRA if I already have a 401(k)?
IRAs can be a great way to supplement your employer-sponsored retirement plan savings. Not only can an IRA give you an opportunity to save more money for retirement, but you may also have access to a wider range of investments than what your employer-sponsored plan offers. For example, you can put your money into insured IRA certificates or savings. Or, you could purchase stocks, bonds and/or mutual funds if you have a brokerage IRA, such as those available through Navy Federal Financial Group.4