Understanding IRAs
Photo by Scott Graham on Unsplash
When I first decided to do this blog, my initial process was to bring some clarity to young people like me on realistic ideas about retirement. In learning about retirement savings, one topic that kept coming up was IRAs. If I am being completely honest, I wasn’t really sure what they entailed. I assumed they were just a different name for type of savings account. After doing some research, I learned that IRAs are essential for helping to provide income in our later years. Also, through my research, I learned it can be a little confusing for a 21-year-old to understand. In this post, I hope to explain IRAs in a way that we can all understand.
An Individual Retirement Account (IRA) is a tax-advantaged investment account that individuals can use to save and invest for retirement, meaning a savings account but better. Depending on the type—Traditional or Roth—an IRA allows you to either defer taxes on your contributions and pay them in retirement or pay taxes now and withdraw funds tax-free later. For a 21-year-old, the earlier you start contributing, the more time your investments must grow through compound interest, which can make a big difference by the time you retire.
There are two major types of IRAs, Traditional and Roth. With a Traditional IRA, you can put up to $7,000 each year into your account. It has several advantages. You are saving money for your future, it reduces your taxes, and the money you save will grow and remain tax free until you withdraw it later in life. For example, if I made 20,000 dollars, and put 5,000 dollars into a traditional IRA, then I would only be taxed on 15,000 dollars this year. Depending on how you have invested it, your IRA money should continue to grow over all of the years you have invested. When you turn 59 ½ years old, you can withdraw your money from your Traditional IRA, without a penalty, but you will pay income taxes on the amount that you withdraw. If you need to remove the money before you are 59 ½ years old, you can do it without a penalty in some limited circumstances, like if you are buying your first home, have educational expenses, or if an emergency occurs where the money is essential. However, in most cases if you remove the money before that age, you will have to pay a 10% penalty in addition to income tax on whatever you withdraw. Therefore, it is best to leave your money untouched.
Roth IRAs are a little more complicated but have some important advantages. With a Roth IRA, you are investing your money after paying taxes on it. Then when you retire, you can withdraw the money and not have to pay taxes on it. In simpler terms, if I were to put my already taxed paycheck into a Roth IRA, it can grow without being taxed. Like the traditional IRA, you cannot withdraw your money until you are 59 ½ years old. Roth IRAs can be really beneficial when you are young. Your investment has a long time to grow, and you are sometimes in a lower tax bracket when you are just starting out in your career. Roth does have the same consequences for early withdrawal as the Traditional IRA. It also has the same investment limit of 7000 dollars a year.
There are many different organizations where you can open either type of IRA. There is a lot of valuable information available on the IRS website and places like Investopedia. I even did some research on Fidelity Investments web site. While researching and writing this post, I have learned a lot about what it means to open an IRA, especially the value of opening one at my age. Investing early is essential to attaining a comfortable retirement, and there are many different options to choose from. I hope this information has helped to answer some questions you might’ve had already and made the topic a little easier to understand. I know it helped me.
