An IRA, (Individual Retirement Arrangement), often called an Individual Retirement Account, is a benefit afforded to all US citizens with earned income. Simplified, IRA accounts, and other qualified retirement accounts (401K’s, 403b’s, etc..), can be thought of as bank accounts specially designated for retirement savings. However, unlike traditional personal savings accounts, these accounts provide tax incentives for saving and must be held by a third party “trustee” or “custodian” who ensures proper reporting and oversight. A common misconception is that the IRA itself is an investment. But rather, the IRA account is simply the bucket in which various investments may be held.
Any cash deposited in the IRA bucket may sit idle or be used for investment in a variety of asset types including stocks, bonds, real estate, and so much more. The benefit of investing using IRA funds versus personal funds boils down to tax advantage. That is, that the investment income generated by IRA accounts is either tax deferred, or may be completely tax free; depending on the IRA account type. In short, investing with retirement money eliminates the need to pay the capital gains taxes you would pay if the same investment was made using personal money; which over the course of a lifetime, will compound and grow more rapidly than personal (taxable) funds.
As an example, lets say you have the opportunity to invest $100,000 in an upcoming real estate development investment. You anticipate that the full investment will be returned within 6 months, plus a gain on investment of $20,000 – not too bad. However, if the investment was made using personal (taxable) money, then the $20,000 investment gain will be taxed as short-terms capital gains income, which in some cases can be as high as 37%. In this case your $20,000 gain is actually only worth $12,600 after paying tax. If wishing to redeploy these funds, you will only have $112,600 to reinvest. Conversely, if the same investment were made using an IRA account, then no tax would be due on the investment gain; thus you are able to reinvest the full $120,000 into the next development investment.
IRA Account Types:
In a Traditional IRA, cash is contributed into the account “pre-tax,” which means any cash contribution/deposits are tax-deductible from that tax year’s personal income. That cash can then buy assets (stocks, real estate, gold, etc.) When the account holder reaches 59.5 years of age, she or he can withdraw from the account and pay taxes on the amount withdrawn.
In a Roth IRA, cash is put into the account “post-tax.” That cash can then buy assets (stocks, real estate, gold, etc.). When the account holder reaches 59.5 years of age, she or he can withdraw from the account tax-free.
This account type allows an employer (typically a small business or self-employed individual) to make contributions into an IRA established in the employee’s name, instead of into a pension fund in the company’s name. A SEP IRA (Simplified Employee Pension) provides the same tax advantages for the account holder as a Traditional IRA.
A SIMPLE IRA (Savings Incentive Match Plan for Employees) features an employer matching and employee’s contributions into an employee’s plan. A SIMPLE IRA provides the same tax advantages for the account holder as a Traditional IRA.
A Beneficiary IRA is also known as an Inherited IRA. At the time of death, the cash and assets in the IRA pass on to the designated beneficiaries for that account. There are some special rules that apply to an IRA that is inherited by a beneficiary. Generally speaking, beneficiaries are unable to contribute to the inherited IRA account and are required to take minimum annual withdraws from the account. If the beneficiary is a spouse however, then the inheriting spouse may choose to treat the account as their own and would not be required to take annual withdrawals. Additional information on these account types may be found in IRS publication 590.
While IRA accounts are great tools for generating retirement wealth, unfortunately not everybody may take full advantage of them. This is due to eligibility restrictions. If eligible, which most are, you will be limited to the amount of cash you are able to personally contribute to your IRA account each year; the maximum contribution amount will vary based on a few factors including your age, income, and IRA account type. Personal contributions made to an IRA account will generally be afforded a deduct-ability benefit, meaning you may deduct the contributed amount from the ordinary income reported on your taxes for the tax year in which the contribution was made. This benefit only applies to pre-tax IRA accounts and may also be affected by your income if you are considered a high earner.
Below you will find a simple chart showing the IRA contribution limits for individual (personal) accounts for 2018 and 2019
|Traditional IRA and Roth IRA Contribution Limits||2018||2019|
|Up to age 50||$5,500||$6,000|
|Catch-Up Contributions Age 50+||$1,000||$1,000|
|Total Contribution if Over the Age of 50||$6,500||$7,500|
In terms of withdrawing funds from these accounts, depending on the account type (pre-tax or post-tax), withdrawals made from the IRA account will be taxed either as ordinary income or not at all (respectively). However, in true IRS form, there are restrictions on when you are permitted to withdraw from the account. As of this writing the designated retirement age is 59.5. Withdrawing from your IRA account prior to that age will result in a 10% penalty for early withdrawal (some exceptions apply).
As you can see there is a certain degree of competency needed to effectively utilize these retirement tools as a part of your overall tax and retirement strategy. In spite of this, the majority of Americans can, and do, utilize these tax advantaged accounts to a certain degree. Unfortunately most treat them as a kind of set-it and forget-it investment account and pray for the best. However, it does not need to be this way. Utilizing the checkbook control IRA, or any self-directed strategy for that matter, will allow you to better forecast your retirement worth by placing the power in your hands.