Articles 10 Questions to Ask When Considering an IRA

March 27, 2015

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 two 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.*

  • 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 five years and being at least age 59½ when you start distributions.*

There is 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. Visit Navy Federal to learn more about SEP IRAs.

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 five 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 would prefer to have tax-free income in retirement.

5. Who can open and contribute to an IRA?

Anyone under age 70½ 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 is no age restriction.

6. How much can I contribute to an IRA?

The annual contribution limit for 2016 is $5,500 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 $6,500 for 2016.

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 70½ or face a tax penalty.** With a Roth IRA, you don't have to make required minimum distributions during your lifetime.

9. What is 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 are not 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 are not 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 can 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.***

*Premature withdrawals from either type of IRA will be taxed at ordinary income tax rates and are subject to a 10 percent IRS penalty.
**Failure to make required minimum distributions may result in a tax penalty of 50 percent of the amount that should have been withdrawn but wasn't.
***Investments in stocks, bonds and mutual funds are not insured by any federal government agency, are not deposits of Navy Federal and may lose value, including possible loss of principal amount invested.

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Nondeposit products offered through Navy Federal Brokerage Services, LLC (NFBS), member FINRA/SIPC. Insurance products sold through licensed agents appointed with various companies. Investment advisory services offered through Navy Federal Asset Management, LLC (NFAM). NFBS and NFAM operate under the marketing name of Navy Federal Investments & Insurance. Nondeposit investment products are not federally insured, are not obligations of the credit union, are not guaranteed by the credit union or any affiliated entity, and involve investment risks, including loss of principal, and may be offered by an employee who serves both functions of accepting members' deposits and the selling of nondeposit investment products. NFBS and NFAM products are not offered, recommended, sanctioned or encouraged by the Federal Government. Office of Supervisory Jurisdiction, 12851 Worldgate Drive, Herndon, VA 20170; phone 1-877-221-8108; fax 703-332-0424.

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An investor should consider, before investing, whether the investor's or designated beneficiary's home state offers any state tax or other benefits that are only available for investments in such state's qualified tuition program.

If a municipal fund security describes one or more of their investment options as having the characteristics of a money market fund, it is important to know that an investment in the security is not insured or guaranteed by the FDIC or any other government agency (unless such guarantee is specifically provided by or on behalf of such issuer) and, if the security is held out as maintaining a stable net asset value, that although the issuer seeks to preserve the value of the investment at $1.00 per share or such other applicable fixed share price, it is possible to lose money by investing in the security.