If you already contribute to a 401(k) or another retirement account through work, you may not have spent much time thinking about opening an individual retirement account (IRA). However, an IRA might provide you with a way to boost your savings even further.
Both traditional and Roth IRAs can present a prime opportunity to set aside tax-advantaged—or even post-tax—funds for your future. IRAs are not complicated, but they are subject to some common misconceptions.[1]
Fortunately, you can learn more about four common IRA mistakes and how you can avoid them.
#1: Not Understanding the Different IRA Types
Savers can contribute to a Roth IRA, a traditional IRA, or both. However, the maximum contribution across all IRAs is $6,000 per person for 2021 (or $7,000 if you're age 50 or older).1 You can contribute $3,000 to a traditional and $3,000 to a Roth, zero to a traditional and $6,000 to a Roth, or any other combination, as long as the total is no more than $6,000.
A traditional IRA is similar to a 401(k) in that its contributions are tax-deductible as long as your income meets certain parameters. When you withdraw funds from a traditional IRA, you will pay taxes on them at that time.[2]
A Roth IRA, on the other hand, is funded through post-tax contributions. This allows withdrawals and gains to be tax-free.[3]
#2: Not Funding the Right Type of IRA
There is no one "right" type of IRA for every situation. However, the amount and type of IRA you fund could have a significant impact on your taxes and your future retirement assets.[4]
People often choose a traditional IRA to reduce how much tax they are paying in a particular year. With a traditional IRA, you put off paying taxes until you make a withdrawal. Depending on your income at the time of withdrawal, you might end up with a lower tax rate.
But for those who don't expect their tax rate in retirement to be lower than it is now, a Roth IRA can essentially allow for the prepayment of these taxes—and the tax-free growth of investments and dividends can be a major boost to your savings.
Many savers opt to split the difference by funding both types of IRA or alternating contributions from year to year.
#3: Ignoring Your Investment Options
Although it is never the wrong time to save for retirement, putting funds aside in an IRA and then leaving them in cash—or putting them in risky or speculative investments—could diminish your returns. Because an IRA is portable and can easily be transferred from one institution to another (unlike a 401(k)), there's little reason to be stuck with bad investments. Move your IRA to a financial
institution with resources that can help you ensure that your investments reflect your desired asset allocation, risk tolerance, and projected retirement date.[5]
#4: Failing to Take Advantage of Catch-Up Contributions
Those aged 50 and up may have no plans to retire soon, but can still take advantage of the ability to contribute an extra $1,000 per year to an IRA.[6] For someone who retires at 65, this can mean an extra $15,000 in retirement savings—on top of the nearly $90,000 in regular contributions--plus any gains. If you got a late start at saving for retirement, the catch-up contribution can present a great opportunity to turbo-charge your savings.
Important Disclosures:
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.
The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
Asset allocation does not ensure a profit or protect against a loss. 1 https://www.investopedia.com/roth-and-traditional-ira-contribution-limits-for-2021-5085118
[1][1] https://www.investopedia.com/ask/answers/102714/how-are-ira-withdrawals-taxed.asp [2] https://www.investopedia.com/retirement/roth-vs-traditional-ira-which-is-right-for-you/ [3] https://www.schwab.com/ira/roth-ira/what-is-a-roth-ira [4] https://www.nerdwallet.com/article/investing/roth-or-traditional-ira-account [5] https://www.investopedia.com/retirement/avoid-mistakes-moving-retirement-plan-assets/ [6] https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-catch-up-contributions
Sources
https://www.investopedia.com/ask/answers/102714/how-are-ira-withdrawals-taxed.asp
https://www.investopedia.com/retirement/roth-vs-traditional-ira-which-is-right-for-you/
https://www.schwab.com/ira/roth-ira/what-is-a-roth-ira
https://www.nerdwallet.com/article/investing/roth-or-traditional-ira-account
https://www.investopedia.com/retirement/avoid-mistakes-moving-retirement-plan-assets/ https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-catch-up-contributions
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