Fully understanding your retirement savings options can make a significant difference in your long-term financial future. One option that you may consider is an Individual Retirement Account (IRA). IRAs offer valuable tax advantages that can help your savings grow over time, whether you're just beginning your career, self-employed, or beginning to plan for retirement later in life. Before deciding whether an IRA is the right fit for your financial goals, it's helpful to understand who can contribute, how different types of IRAs work, and the potential tax benefits they offer.

What can fund an IRA

There is a common misconception that IRAs are only for office workers. The truth is that you can fund one with taxable compensation—such as wages, salaries, commissions, tips, bonuses, or net income—from self-employment. Additionally, certain alimony and maintenance payments, money received to aid in graduate or postdoctoral studies, or even certain difficulty-of-care payments may also be treated as compensation that can be used to contribute to an IRA. It’s also important to note that there is no longer an age limit to contribute to an IRA, which was previously capped at age 70 1/2.

Traditional IRAs

If you create a traditional IRA, you may be able to deduct some or all of your contributions to the account from your income taxes. You also may be eligible for a tax credit equal to a percentage of your contribution. Amounts in your traditional IRA, including earnings, generally aren't taxed until they are distributed to you. This typically happens during retirement when you may be in a lower income bracket. After your death, any remaining funds in your IRA will be paid to your beneficiaries.

Distributions from a traditional IRA are fully or partially taxable in the year of distribution. Additionally, any money taken out before age 59 1/2 may be subject to an additional 10% tax. You also may owe an excise tax if you don't begin to withdraw minimum distributions by April 1 of the year after the year you reach age 72 (this was raised from 70 1/2).

Roth IRAs

A Roth IRA is the reverse of a traditional IRA in that contributions to such an account aren't deductible and you don't report the contributions on your tax return. However, you don't pay taxes when you take distributions. To be a Roth IRA, an account must be designated as a Roth IRA when it's set up. This type of account may be a good choice for someone early in their career, for example, who is in a low-income bracket now but expects to be in a higher one later.

Final thoughts

This is just an introduction to IRAs. There are other considerations as well, such as limits on how much you can contribute or if you have a work-related plan, such as a 401(k), which may also impact your IRA status. If you have questions about if an IRA is the right choice for you, we are here to help. Contact us using the form on this page with questions.

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