Personal Banking 101: Understanding Your IRA Options

March 29, 2021
Retirement might be years away or right around the corner. Many financial experts suggest you aim for 85 percent of your pre-retirement income to live comfortably after you stop working. Individual retirement accounts (or IRAs) offer a way to save that money, helping it to grow over time.

Two types of IRAs are available through 1st United: traditional IRAs and Roth IRAs. Knowing how they differ is important as you plan your finances and save for what, hopefully, will be a wonderful retirement.

What is an IRA?

An IRA is a federally-established savings tool that allows you to contribute your own money towards retirement. It differs from a 401(k) in that a 401(k) is a retirement account provided by an employer to its employees (and, if you’re lucky, your employer contributes to or matches your contributions). Self-employed people can also set up a 401(k) for themselves. You can have both a 401(k) and an IRA.

IRAs differ from savings accounts in that you’re doing more than saving. By contributing, you’re committing to use that money for retirement and not before. Withdrawing money early could incur hefty penalties. If you need to be able to have access to your money, a savings account or certificate is a better option for short-term needs.

In 2021, the maximum amount you can contribute to either a traditional IRA or a Roth IRA is $6,000 a year, $7,000 if you are over the age of 50. This amount could change every year so be sure to check the guidelines at irs.gov. The only exception to these limits is a rollover IRA. If you have a 401(k) account from a previous job, you can move all of your funds into a traditional IRA without a tax penalty.

You also can have both types of IRAs but the combined contribution amount cannot exceed $6,000/$7,000 in a year.

The traditional IRA

A traditional IRA allows you to save for retirement and contributions are tax-free at the time they are made. You will, however, pay taxes when you begin withdrawing from the account sometime after age 59 ½. 

The initial tax-free nature of this IRA means you might be able to lower your current tax bill. The IRS allows you to contribute to the previous year’s account or open a new one until tax day (typically April 15). Many tax programs and tax professionals will notify you of this benefit, which could lower your taxable income while investing for retirement. Please review the IRA tax deduction guidelines through the IRS and consult with a tax professional for your specific situation.

Here are some other things you need to know about a traditional IRA:
  • Anyone with earned income, regardless of how much they earned, can contribute to an IRA.
  • You must start withdrawing from the account at age 72.
  • Under most circumstances, if you withdraw contributions or earnings before age 59 ½, you’ll be subject to a 10 percent penalty. There are exceptions to this, however.

The Roth IRA

The Roth IRA flips the tax benefit, so you are taxed at the time the contribution is made but not when you start withdrawing at age 59 ½ or later. You won’t pay a penny of taxes from a Roth when you retire, but you won’t be able to deduct your contribution in the present. A Roth IRA tends to provide more benefit to people who foresee themselves in a higher tax bracket in the future.

A contribution to a Roth IRA won’t reduce your tax bill like a traditional IRA might, but you can keep contributing to the previous year’s account through April 15. Here are a few other things you should know about a Roth IRA:

  • For 2021, a full contribution to the account is limited to single filers making less than $125,000 a year or joint filers making less than $198,000. A partial contribution is available up to $140,000 for single filers and $208,000 for joint filers.
  • There is no mandatory distribution age when you must withdraw from the account.
  • You can withdraw earnings without penalty at age 59 ½ and after the account is five years old. There are also exceptions to this rule and you can withdraw contributions (but not earnings) from the account at any time, because you already paid taxes on them.

Which is best for you?

Both traditional and Roth IRAs achieve the same important goal – saving for retirement. Understanding their differences is important in choosing the IRA that’s best for you.

A traditional IRA might be a better choice if:

  • You are younger and have less disposable income.
  • You think you’ll be in a lower tax bracket after retirement.
  • You won’t need to draw cash from your account anytime before retirement.

A Roth IRA might be better a good choice if:

  • You’re investing later in life and don’t plan to draw from your account until after retirement.
  • You have other retirement accounts, such as a 401(k), that are tax-free. You won't necessarily need that IRA benefit.
  • You foresee needing to dip into your account before retirement.
  • You expect to spend more, such as on travel or a second property, in retirement.
Ultimately, your decision will come down to whether you want to pay taxes on your retirement savings now or later. Either way, an IRA is a great way to save for a future that you should be preparing for now. At 1st United, we offer both traditional and Roth IRAs to our members and can help you figure out which is best for you. Contact us to learn more.

1st United Credit Union cannot give tax advice. Please consult your tax advisor or visit irs.gov.