Is an IRA for you: A discussion of the Roth and Traditional IRA

We hear of concerns about individuals getting near retirement and not being prepared and we also hear of concerns about Social Security. Can an individual retirement account help? Jeff Romine, partner, with the Financial Planners of Missouri, to discuss this topic.

Question: One hears about individuals nearing retirement being il-prepared. Can Individual Retirement Accounts be helpful?

Asnwer: We advocate that people have a plan for their retirement. It is not uncommon for individuals to spend more time planning a special trip than they spend time planning their entire financial future. We suggest the use of Individual Retirement Accounts inside of a plan for an individual or a couple.

Individual Retirement Accounts or IRAs are designed to help individuals save money for their retirement. This tool makes it possible for a person to plan for a time in their life when they are not working. Two IRAs are most common. The traditional IRA has been available for several decades, with the Roth IRA a more recent development.

Question: When should one start saving in an IRA?

Answer: One should start saving as early as possible. Although I believe that you should have an emergency fund, cash flow savings and a â??big ticket accountâ?? before starting on saving for retirement, it is important to start as early as one can to have earnings for a longer period of time.

If you are 20 years old and you save $50 per week, by age 65 you might have around $500,000, but if you wait until you are 30, to save $50 per week, you will have about half as much. This is partially due to compound interest. Albert Enstein referred to compound interest as the 8th wonder of the world.

Question: Who is eligible to contribute and how much can they contribute?

Asnwer: First, to be eligible you must have income from your own earnings such as wages or a salary. Or if you are married, your eligibility can be based on your spouses earnings. If you are under 50 your maximum contribution is $5,500 per year and if you are 50 or over that increases by $1,000. There are some restrictions on high income earners and people with defined benefit pensions. These individuals would want to talk to their tax advisors.

Question: How does an IRA work?

Answer: The two IRAs that are most common, Traditional or Roth, work quite differently. The traditional IRA provides an interesting opportunity. If you qualify and you make an IRA contribution, you can reduce your income and your income taxes for the year that you make the contribution and then years later, when you take a distribution from your IRA, you record the income and pay income taxes on the income, hopefully at a lower rate. The IRS requires that you start recognising income at the age of 70 1/2. So it might be beneficial to defer the income taxes to a later time, when perhaps you are in a lower tax bracket.

The Roth IRA is different, here you make a contribution after you have paid taxes on the money. Now in this case, when you take a distribution from the IRA, you will not have any taxes to pay on either the IRA or its growth. Both make it possible to use this vehicle as a means of saving for your retirement.

Typically it is best for those who expect to retire on less income to use a traditional IRA and those whose income is still growing, like younger workers, might benefit from a Roth IRA.

Question: What investments can one have in an IRA?

Answer: The phrase IRA is an IRS term to describe the tax status of an investment. Therefore almost any investment can reside in an IRA. This includes investments such as: CDs, mutual funds, shares of stock, and annuity contracts. Even real estate and other investments can be included with some effort. There is a relatively small list of items that you cannot invest in.

We always recommend that one consider their risk tolerance and time horizon before making any investment.

Question: Where would you go to make an investment in an IRA?

Answer: Wherever you can save or invest money, you can typically open an IRA. Some of the places include: banks, online banks and investment houses, and virtually all broker dealers.

We always recommend the importance of having an overall financial plan. This assures that your resources are allocated in a way that best serves your future needs.

Jeff Romine Ph.D., CPA, Investment Advisor Representative

Financial Planners of Missouri

110 S. Franklin

Kirksville, MO. 63501