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Only 10% of today's private-sector workers can count on retiring with defined benefit plans, which used to be standard. That means you have to take charge of your own money if you want to retire well.
Possibilities include a 401(k), if your employer offers one, or an Individual Retirement Account. IRAs are a great way to jump-start retirement saving if your employer doesn't offer retirement benefits, or if you're self-employed. You can also use one along with your 401(k) to maximize your retirement savings. Almost anyone can open an IRA, and odds are, one is right for you.
How do IRAs work?
That depends on what type of IRA you have. IRAs are usually funded by individual contributions. You can open them at a bank or at most brokerages. Some brokerages offer IRAs without annual fees, and they're often exempt from minimum trading requirements. Beyond that, different types of IRAs have different tax features:
- Traditional IRA. For tax purposes, traditional IRAs operate like 401(k)s. As long as you (or you and your spouse) meet income guidelines, the money you contribute is taxed when you withdraw it, not before you deposit it. If you're not covered by a retirement plan at work, any money you contribute to a traditional IRA is tax deductible, no matter your income.
- Roth IRA. Contributions to Roth IRAs are post-tax. Because you deposit money that's already been taxed, you don't pay taxes when you withdraw money during retirement. So Roth IRAs are a great choice for younger workers, whose tax rates will probably rise later in life.
You could also open a SEP IRA, a Simple IRA, or a Self-Directed IRA. These plans are usually run by someone other than the planholder, like an employer -- they may be more popular among small businesses, since the administration costs are lower than with a 401(k) -- or a custodian.
Who can have an IRA?
There are some limits on IRA eligibility. You can't contribute to a traditional IRA once you're 70 1/2. And while there are no age limits for Roth IRAs, you can't contribute once you hit a certain income level. Married couples who file jointly can make only a reduced contribution if their modified AGI is more than $178,000 and less than $188,000. Above $188,000, they're completely ineligible. For singles, reductions begin at $112,000, and contributions are phased out at $127,000, as of 2013. But even if your income is too high, you might be able to use a backdoor Roth IRA.
What are the disadvantages of IRAs?
Though IRAs are a great way to begin your retirement savings, or supplement another strategy, they shouldn't be your only way of saving, because of their low annual contribution limit. In 2014, you'll be able to contribute up to $5,500 to a traditional or Roth IRA, with an additional $1,000 in catch-up contributions allowed if you're 50 or older. If you contribute the maximum each year for 40 years, you'll end up with a lot of money, but not enough to live the 20 or 30 years you can expect after retirement.
What else are IRAs good for?
IRAs also provide a convenient way to consolidate old 401(k)s. If you're leaving a job with retirement benefits, rather than cashing out or leaving the money in an account you have little control over, simply roll over your 401(k) balance into an IRA. For no-fee IRAs with great investments, consider TD Ameritrade, TradeKing, or E*Trade. If you already have an account, just tell your broker you'd like to execute a rollover, and follow their instructions from there. Rolling over your 401(k)s can save you from monitoring a bunch of retirement accounts, cost you less in fees, and give you a much wider selection of investments.
The bottom line
IRAs aren't the only tool you'll need to reach an independent retirement, but they complement a 401(k). They let you save even more, and they can save you on taxes after you retire. And like 401(k)s, IRAs are fairly low maintenance. Occasionally rebalancing your investment choices -- many experts recommend quarterly or yearly -- should be enough to keep you on track toward your financial goals.
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