When it comes to retirement planning, Sacramento couples need to know it is never too late to start. If you believe that you can safely rely on your Social Security benefits, you might be unpleasantly surprised. Instead of taking that risk, be proactive and create your comprehensive retirement plan now. That way, you can relax and enjoy your retirement the way you always hoped you would. One simple way to get started is by opening Individual Retirement Plans, which can help you start saving and investing in your future.
IRAs and how they work
An Individual Retirement Account, or IRA, is basically an investment account that provides tax advantages along with a reliable way to save money for retirement. IRAs do not require you to pay taxes on the investment earnings from the account. Instead, these earnings can be reinvested and compounded so that your account will experience as much growth as possible. Then, after you reach retirement age and start making withdrawals from your IRA, the tax consequences depend on three factors. Those factors include the type of IRA you have, your present income and the amount of your withdrawals.
The various kinds of IRAs available
There are basically four different kinds of IRAs, each with its own advantages. Traditional IRAs and Roth IRAs are opened by individuals, as opposed to Simplified Employee Pension (SEP) and a Savings Incentive Match Plan for Employees (SIMPLE) are made available through employers. Regardless, all IRAs are considered “fully vested.” This means that all contributions and earnings belong to the individual, even those contributions made by their employers.
Contribution amounts may be limited
The IRS has imposed certain limitations on the total amount of contributions that can be made to an IRA account each year. These limitations usually change each year, therefore, it is wise to consult with your retirement planning Sacramento attorney to determine the current limitations being imposed.
In 2016, the maximum contribution for both Traditional and Roth IRAs is $5,500, for individuals under the age of 50. For those over age 50, the limit is $6,500. The maximum contribution for a SEP IRA is $53,000. The limit for a SIMPLE IRA is $12,500 if you are under age 50 and $15,500 if you are older.
How traditional IRAs and Roth IRAs are different
A traditional IRA is different from a Roth IRA because it is funded with “pre-tax” dollars. That means you do not pay any taxes on your contributions or the interest those contributions earn until you start taking withdrawals during your retirement. At that point, each withdrawal you make is taxed as ordinary income.
However, a Roth IRA is funded with “after-tax” dollars. A Roth IRA does not provide any tax benefits relating to contributions. But, the earnings and withdrawals from Roth IRAs are generally tax-free. A major benefit of a Roth IRA is that, not only are your earnings allowed to increase tax-free, but when you retire and begin receiving withdrawals, you do not pay income taxes. Essentially, you can avoid taxes when you contribute to a traditional IRA, but you avoid taxes with a Roth IRA when you withdraw money at retirement.
How early withdrawal penalties
With all IRAs, the government charges a penalty for early distributions or withdrawals. With a traditional IRA, you will pay an additional 10% penalty if you take any distributions before you reach the age of 59½. The penalty is in addition to the income taxes that are imposed. One benefit of a Roth IRA is that you can withdraw your original contributions at any time, without penalty because you essentially paid income tax on those funds already. However, early withdrawals of your earnings are subject to the 10% penalty, in addition to income tax. The Roth IRA has an additional requirement. Along with the age requirement of 59½, a Roth IRA must be in existence for at least five years before you can begin to withdraw earnings, without penalty.
How employer-sponsored IRAs are different
An employer must have a maximum of 100 employees, earning more than $5000 each, in order to sponsor a SIMPLE IRA for its employees. Yet, there cannot be any other form of retirement plan made available to employees. The maximum contribution to a SEP IRA this year is $53,000. The maximum contribution to a SIMPLE IRA is $12,500, if you are under age 50, and $15,500 if you are older than 50. The employer-sponsored IRAs (SIMPLE and SEP) can also be used by self-employed individuals and small business owners.
If you have questions regarding your planning needs, contact the Northern California Center for Estate Planning and Elder Law for a consultation, either online or by calling us at (916) 437-3500.