When you’re deciding how to save money for retirement, the sheer number of options can be overwhelming. But don’t overlook one safe and interest-bearing possibility for your money, which often flies under the radar: the IRA savings account.
For Bert Doerhoff, a wealth advisor at Aura Wealth Advisors, helping clients navigate the risks and rewards of saving and investing for a financially secure retirement is all in a day’s work. Here, Doerhoff walks through the benefits and features of IRA savings accounts and helps answer a question you may have, whether you’re nearing retirement or just starting to think about it: “What is an IRA savings account, and how does it work?”
What is an IRA savings account?
Saving and planning for retirement is a lot like the epic journeys you see in big-budget sci-fi and fantasy movies—but with less magic and fewer dragons. As you embark on your own path to retirement, an IRA savings account can be your trusty sidekick—dependable and comforting.
However, you may be asking, “What is an IRA savings account?” An IRA savings account combines the safety and reliable returns of a savings account with the tax benefits of an IRA, and it can play an important role as you consider how to plan for retirement.
When you open an IRA savings account, the amount of money you contribute to it counts toward your annual IRA contribution limit. For 2022, the IRA contribution limit is $6,000 for people under age 50 and $7,000 for people age 50 or older. Certain factors may reduce amounts you can contribute or take a tax deduction for the contribution.
Unlike an IRA CD account, an IRA savings account doesn’t typically require a minimum deposit. This makes it a great option for savers at any budget level. An IRA savings account also affords you more flexibility, as you can make withdrawals without triggering bank penalties. Keep in mind that you may have an IRS early withdrawal penalty if you withdraw your funds prior to age 59½. Consider consulting a tax advisor to discuss your specific situation.
In contrast to stocks, exchange traded funds, and mutual funds, an IRA savings account returns a good rate that isn’t tied to the swings of the stock market.
The 3 biggest benefits of an IRA savings account
It’s important to understand how an IRA savings account works as you design the retirement savings strategy that best fits your financial goals. Wherever you are on your path to retirement, keep in mind the three main benefits of integrating an IRA savings account into your retirement savings plan:
1. Safety. The money in your IRA savings account isn’t vulnerable to a market crash. It will always be there when you need it.
2. Good rate of return. Similar to a high-yield savings account, an IRA savings account can provide a solid interest rate.
3. The power of compounding. Over time, your money will grow faster thanks to the power of compound interest.
The advantages don’t stop there. As you investigate how an IRA savings account works, you may want to examine the tax advantages of each type of IRA savings account and how it might play a key role in your retirement savings strategy. Read on to learn more.
What are the tax advantages of an IRA savings account?
IRA savings accounts are available in either a Roth IRA, a Traditional IRA, or both, which allows you to enjoy the unique tax advantages of those savings vehicles. As mentioned above, there may be IRS early withdrawal penalties depending on your plan type and the age at which you withdraw your funds, so you may want to discuss your situation with a tax advisor.
Whether to go the Traditional or the Roth route is an age-old question. “You tell me what’s going to happen at the end of your life, and I’ll tell you what you should do at the beginning,” Doerhoff says. But deciding to go one way or the other—or going half and half—isn’t as important as starting to save for retirement as early as you can, he says.
To decide which type of IRA savings account you need, it may be helpful to understand the unique tax benefits and terms of the Traditional IRA vs. Roth IRA.
Tax advantages of an IRA savings account within a Traditional IRA
If you contribute to an IRA savings account within a Traditional IRA, you may be able to deduct that amount from your income to lower your tax bill. That money then grows tax-free until you decide to withdraw from it in retirement, at which point you pay income tax on the disbursement.
You can begin distributing funds without penalty at age 59½. If you distribute funds before then, you may be subject to an IRS early withdrawal penalty. If you turned 70½ before Dec. 31, 2019, you are subject to the Required Minimum Distribution (RMD) rule, and you must start distributing funds from your Traditional IRA. If you turned 70½ in 2020 or following years, you are not required to begin to take your RMD until you attain age 72.
Tax advantages of an IRA savings account within a Roth IRA
If your IRA savings account is within a Roth IRA, then any contributions can’t be deducted from your income to reduce your annual taxable income. However, when you pull that money out in retirement, you won’t be required to pay taxes on the gains.
With a Roth IRA, you’re allowed to withdraw earnings without penalty at age 59½ if your account is at least five years old. If you distribute funds before then, you may be subject to an IRS early withdrawal penalty. Roth IRAs do not have the RMD rule that Traditional IRAs do. You are not required to distribute earnings once you reach the RMD age required with a Traditional IRA. You can let your account grow tax-free.
How you can use an IRA savings account along your retirement savings journey
With its secure and steady returns that can provide an alternative to the ups and downs of the stock market, the IRA savings account can be a strategic place to keep retirement funds. Doerhoff explains how an IRA savings account works as you move closer to retirement.
Using an IRA savings account early in your retirement savings journey
Too often, Doerhoff says, inexperienced investors will put their first chunk of savings into the stock market, only to panic and sell when the value drops.
“The pain of it going down and seeing your investments lose money is twice as strong as the joy of watching it go up,” he says.
Averaged out over time, the typical portfolio mix will likely be 60% equity and 40% fixed income, Doerhoff says.
By “equity,” Doerhoff is referring to stocks, or shares of publicly traded companies. Stocks are riskier assets than government bonds, corporate bonds, and IRA savings accounts, which all fall under the umbrella of “fixed income” assets.
“Don’t start [with stocks] because it’s going to put that knot in your stomach the first time it drops,” he says.
Instead of diving headfirst into the choppy waters of the stock market, Doerhoff recommends dipping a toe into calmer waters—in an IRA savings account, which has no minimums, offers plenty of flexibility, and provides a good rate of return that isn’t tied to the stock market.
“Start putting your money in an IRA savings account and let it build,” he recommends.
Source: discover.com