MM006: Understanding Retirement Accounts: IRAs

Sometimes you don't have access to a 401(k). Sometimes you want to have more control over which funds you're investing in. Sometimes you just want to have more retirement savings vehicles available to you. The IRA is the unheralded hero of the modern-day retirement savings plan. Find out why.

IN THIS WEEK'S EPISODE

* Understanding the basics of IRA accounts

* Detailing traditional and Roth IRAs, SIMPLE IRAs, SEP IRAs and Individual 401(k)s

* How do IRA contributions work?

* Breaking down the ins-and-outs of how IRAs work in retirement

* Mixing and matching retirement accounts

* My favorite investment firm for IRAs: Vanguard

* How Roth accounts work and why I'm a really big fan

* What happens if you need early access to your IRA funds?

Understanding Retirement Accounts: IRAs

Let’s get started by setting some definitions.

Whereas 401(k)s and other defined contribution plans are set up through your employer, Individual retirement accounts, or IRAs for short, are retirement savings vehicles set up and managed by individuals.

There are several types of IRAs: Traditional IRAs, Roth IRAs, SIMPLE IRAs and SEP IRAs.

Traditional IRAs are one of the more common types of IRAs, and function very similarly to traditional 401(k)s offered at work. Rather than being deducted from your paycheck pre-tax, traditional IRA contributions are tax deductible come tax season (depending on your adjusted gross income), which allow your contributions to grow tax-free until you retire.

If you have no retirement plan at work and you're younger than 70.5, you can contribute $5,500 (or $6,500 if you’re older than 50) and deduct the entire amount from your taxes. If your spouse doesn't work outside the home, they can also invest up to the federal limit and deduct the full amount.

If you do have a 401(k) or other retirement plan at work, your contribution is fully deductible only if your adjusted gross income is less than $61,000 for an individual or $98,000 for a married couple filing jointly. In this case, when you have a workplace retirement plan available, the deduction for your traditional IRA contribution is phased out completely if your AGI $71,000 or more as an individual filer or $118,000 or more for a married couple filing jointly.

If you're not covered by a workplace plan but your spouse is, your contribution is fully deductible if your combined income is less than $184,000 and gets phased out at $194,000 or more.

You will decide in which stocks, bonds and mutual funds you invest in, and will benefit from the contributions growing tax-free (if you fall within the deduction limits previously mentioned).

In retirement, your withdrawals from you traditional IRA account(s) will be taxed as income tax, which may be at a lower tax bracket rate than you would have paid when you were in your peak working years.

Contributions are locked by the same early withdrawal penalty that traditional 401(k)s face: 10% plus income taxes on the withdrawal, so you’ll have access to the funds in an emergency, but as with 401(k) early withdrawals, it should be a last resort.

Roth IRAs are the other common IRA option, and contributions grow with after-tax dollars. More on Roth accounts later.

In addition to the more familiar traditional/Roth IRA plans available, there are three other IRA options available to you are self-employed.