IRA Guide For The Financially Illiterate But Wealthy Investor by Juliette Fairley, RothIRA.com
Chris Stone didn’t start saving for retirement until he quit drinking alcohol at the age of 35. Today, the 49-year-old retiree regrets that he didn’t stop partying sooner. “It’s normal to overspend on socializing when you’re 20 and 30 years old, but it’s expensive,” Stone says. “I think 31 years old is a good age to stop partying.”
Today, Stone has retired with a pension after 17 years of working for the state of Massachusetts. “Instead of spending money at bars with my friends, I started a landscaping business,” says Stone, who lives in Scituate not far from Cape Cod. He is among the 36 percent of people saying they wish they had stuck to a budget, according to the Fall Merrill Edge Report.
Aron Levine, head of Merrill Edge at Bank of America, says that Stone’s experience is not uncommon. “Year over year, we continue to see financial regrets surrounding extraneous spending, particularly with the youngest generations, and it’s visibly impacting their ability to pursue long-term financial goals,” Levine says.
But Americans surveyed also have high hopes that they will catch up. Some 68 percent of Americans believe they’ll save more, 67 percent say they will spend less and 53 percent plan to invest more in 2016.
Simply deciding to save is a big step. One way to do so quickly is to stash money in an Individual Retirement Account (IRA). The advantages of an IRA are tax deductions for contributions and tax-deferred growth over time.
“IRAs give investors far more flexibility than any other type of retirement plan,” says James P. Dowd, CFA, CPA and CEO with North Capital, a registered investment advisory firm in Utah and California.
Up to $5,500 of contributions to a traditional IRA are deductible in the tax year 2015, depending on an individual’s income. For those 50 and older, the deductible amount is $6,500. This allows for savings to grow on a tax deferred basis so that when distributions do take place at retirement, they are taxed as income at the rate the taxpayer is subject to according to IRS rules.
“Assuming the individual is retired, that rate may be lower than it would be if the individual were working,” says Jeff Kelley, senior vice president and chief operating officer with Equity Institutional in Westlake, Ohio.
One of the conveniences of a traditional IRA account is being enabled to use savings in the account as a down payment on a home without having to pay the 10 percent early distribution penalty tax. A Roth IRA has similar allowances except that contributions must be vested for five years before withdrawing money in order to avoid the penalty tax.
Another upside is that regardless of the type of IRA, contributions are permitted by the IRS until the very last minute as long as it was opened before the end of the tax year. “You can make contributions to it until April 15 of the following year, which means you can take advantage of a tax deduction even after the tax year has ended,” says Kelley.
Further, self-directed IRAs allow investors to diversify beyond traditional investments in stocks and bonds by adding alternative investments, such as ETFs, real estate, precious metals and private equity. Investors can even invest IRA funds in startups through crowd funding websites.
A perk of the traditional IRA is that workers are not required to report the money invested in the IRA as income on their tax return. That’s because traditional IRAs are funded with pre-tax money,
The downside, however, is that the IRS requires withdrawals at 70½ years old, at which time those withdrawals are levied at an ordinary income tax rate.
And that can get expensive, according to David Twibell, president of the Custom Portfolio Group, an Englewood, Colorado-based advisory firm that provides personalized investment management and wealth planning services. “For people with large amounts of money in their IRAs, that can cost thousands of dollars each year,” Twibell says.
However, Roth IRAs offer a different tax advantage. First, investors in a Roth will pay taxes on their contributions today but never on the gains or investment returns at retirement age. This option is especially attractive to younger people, as they have a long investing timeline.
“The IRS never forces you to take money out of your Roth IRA, and if you do decide to withdraw funds, you don’t pay any taxes on them,” Twibell says.
That’s why, because of the power of tax-free compounding, Roth IRAs are regarded as the best account type for long-term investing.
For the self-employed individual and small business owner, the Simplified Employee Pension (SEP) and Savings Incentive Match Plan for Employees (SIMPLE) are easy to administer. A SEP allows contributions of up to 25 percent of compensation up to $53,000, and the contribution limit on SIMPLE retirement accounts for 2015 is $12,500, up from $12,000 in 2014. The catch-up limit is $3,000, up from $2,500 in 2014.
Finally, Rollover and Inherited IRAs are created under special circumstances that include quitting a job and starting a new one or when a loved one passes away. “Contributory IRAs are available to anyone with earned income,” Dowd says.
In other words, the sky’s the limit when it comes to how many IRA accounts a person can open, but they may be especially attractive when an employer does not offer a qualified retirement plan, such as a 401k plan, or for those workers who want to supplement their 401k plan because most employer-administered 401k plans have a short list of mutual funds that are available for investment within the plan.
“If you want to invest in something that’s not on the 401k plan menu, tough luck,” says Twibell.
About the Author
Juliette Fairley is a writer for TraditionalIRA.com and RothIRA.com. She is a Manhattan resident who graduated from Columbia University’s Graduate School of Journalism. Her past incarnations include being a TV host for the Discovery Channel, anchoring financial news segments for The Street and writing for the New York Times and the Wall Street Journal.