IN THIS CHAPTER

Starting and investing in an IRA

Being aware of tax issues

Knowing when to take your money out

An individual retirement arrangement, commonly called an IRA, is a great way to save money for retirement. This chapter answers some of the common questions about them.

Where can I start an IRA?

Most financial institutions offer IRAs, including banks, insurance companies, mutual fund companies, brokerage firms, credit unions, and brokers. It can be a bit confusing because most institutions offer a wide range of investment products. Some more so than others. For example, a bank is able to offer an IRA that can be invested in mutual funds, and a mutual fund company can offer an IRA that provides a very wide range of investment alternatives including individual stocks and bonds and even certificates of deposit (CDs).

Do I need to hire a broker or financial advisor to start an IRA?

You don’t need a broker or financial advisor to open an IRA. A broker or financial advisor can help you decide how to invest your money; however, they don’t work for free. They often recommend a managed account that usually is just a mix of mutual funds that have an additional fee other than the mutual fund management fees. You can obtain a similar mix of investments from a mutual fund company without paying any extra fees, and some companies, such as Vanguard and Fidelity, offer a lot more alternatives than just their own mutual funds. They also have staffs that can help you select your investments with or without an extra fee.

How much can I contribute to my IRA?

You can contribute $6,000 per year plus an additional $1,000 if you’re 50 or older and if you have at least this amount of taxable income during 2021. The contribution limits are the same for traditional and Roth IRAs.

The amount you can contribute is reduced or eliminated if you or your spouse is covered by an employer-provided retirement plan.

What tax breaks do I get for having an IRA?

You get a tax deduction for contributions you deposit into a traditional IRA, plus your contributions grow without being taxed. All withdrawals are taxable, including a 10 percent penalty tax if they’re withdrawn prior to age 59½ unless the withdrawal is for a reason that is exempt from the penalty tax.

Contributions to a Roth IRA aren’t tax deductible but they grow without being taxed. Withdrawals aren’t taxable if you follow all the rules.

How do I take money out of my IRA?

You can take money out of a traditional IRA or a Roth IRA anytime you want to by notifying the institution that holds your account.

Taking money out often means tax consequences. Chapter 16 has more information on withdrawal issues.

How much tax do I have to pay when I withdraw money from my IRA?

Withdrawals from a traditional IRA are taxable as part of your adjusted gross income when you file taxes each year. You may also have to pay a 10 percent tax penalty if you withdraw funds prior to age 59½.

Withdrawals from a Roth IRA are not taxable if you are over age 59½, and your account is at least five years old. Withdrawals prior to age 59½ are also not taxed if they are made for certain special reasons. See Chapter 16 for the details.

What can I invest in through my IRA?

You may legally invest in just about anything except life insurance and collectibles. You can invest in real estate; however, you may not receive any direct benefits such as receiving rental income that is paid to you rather than your IRA account, and you may not live in the property. You will need a special custodian rather than a bank or other financial institution when you invest in non-traditional investments.

Having so many options is a huge plus for those of you who like a lot of investment flexibility; however, it can be intimidating if you’re not investment savvy. Target Date Maturity mutual funds are an easy solution for those in the latter category because the fund manager puts your money into a broad mix of stocks and bonds that are considered by investment professionals to give you the right mix for your age.

What’s the safest way to invest my IRA money?

I have found the biggest fear people have when investing is that they will lose everything. When I speak to an audience of retirement plan investors, I tell them that there isn’t any place they can invest their money and be sure they won’t be wiped out during a major worldwide financial meltdown like the Great Depression. I then say I know some of you will tell me your money will be safe if you put it into CDs. I then explain that CDs that have federal backing through the Federal Deposit Insurance Company (FDIC) work successfully when the number of bank failures each year are within a predictable range. FDIC protection won’t be sufficient during a total economic meltdown.

The best protection you can have over the long haul is to be widely divested — that is, to be invested in many different things. You can do well even when one or more of your investments are terrible. I can confirm this because I have made some really bad investments; however, I have made enough good ones that I am okay.

Is my IRA insured?

Your IRA receives FDIC protection if you invest in CDs that are FDIC protected. Many CD buyers get them from banks, but FDIC-backed CDs are also available through brokerage firms. However, as I mentioned in the preceding section, the FDIC has limited resources.

Your other IRA investments aren’t insured even when you use a bank to buy them.

Can I start an IRA for my spouse and/or children?

There isn’t any minimum age for opening a traditional or Roth IRA; however, a child must have earned income to have an account. The account must also have a custodian if the child is a minor. People 18 and older are considered adults in most states, but the age of maturity is 19 or 21 in other states.

You can also open an IRA for a non-employed spouse. The contribution limit is $6,000 under age 50 plus an additional $1,000 when the spouse is age 50 or older during 2021. The employed spouse must have sufficient earned income to cover all the IRA contributions. The employed spouse’s participation in a 401(k) can reduce or eliminate the spouse’s traditional IRA contribution.

When do I have to start taking money out of my IRA?

Required minimum distributions (RMDs) must begin once you reach age 72 for a traditional IRA. The initial distribution must be taken no later than April 1 of the year following the calendar year during which you reach age 72. There are several different ways of computing the amount that must be withdrawn. No RMDs are required for a Roth IRA until the account holder’s death. There is a severe tax penalty for failing to comply with the RMD requirements. Chapter 17 explains RMDs.