If you want to make a resolution that will pay off in the long run, the first thing you should do in 2017 is to open an IRA. Anyone can contribute to this tax-favored retirement account, and with a couple of different options to choose from, there's an IRA that will fit your particular needs and financial situation. Everyone knows that saving for retirement is important, and there's no better time than now to get moving. Below, we'll look at the basics of IRAs and why you shouldn't hesitate to start using them today.
Why IRAs are so useful
IRAs are a great vehicle for saving for retirement. In 2016 and 2017, anyone can contribute up to $5,500 to an IRA, as long as they have at least that much in earned income for the year. Those who are 50 or older get an additional $1,000 as a catch-up contribution to encourage savers to ramp up their contributions as they approach retirement.
IRAs come in two different flavors: traditional and Roth. Traditional IRAs offer the ability for many taxpayers to get an upfront deduction for the amount they contribute. The chance at immediate tax savings is what makes traditional IRAs so popular. In addition, money grows in the IRA on a tax-deferred basis until you withdraw money in retirement. Only at that point will you pay tax on the money you contributed and the appreciation in value over the course of your career.
Roth IRAs work differently. Rather than providing an upfront deduction, Roth IRAs require you to contribute after-tax money. However, not only do you get tax-deferred growth while the money's in the Roth IRA, you also typically won't have to pay any tax on the money you take out of the Roth IRA in retirement.
Why now's the best time to open an IRA
IRAs are well-known for being a great last-minute tax planning tool. You can make IRA contributions for any given year until the official mid-April tax filing deadline for your tax return for that year. For instance, you can make an IRA contribution for the 2016 tax year up until April 18, 2017 -- and still claim it on your 2016 tax return.
That flexibility is useful, but it also creates bad habits. Those who funded their 2016 IRAs last January took full advantage of the double-digit percentage increases that the stock market produced last year. That's something that those who wait until April 2017 to contribute will miss out on. Of course, there's no guarantee that short-term results will always be positive, but with the general upward trend in the stock market over the course of its history, the odds favor those who make early contributions over those who procrastinate.
A couple things you need to know about IRAs
Even with all their benefits, there are some things to keep in mind with IRAs. First, not everyone is allowed to open all types of IRAs, and the tax benefits are different for some taxpayers. For instance, there are income limits above which people aren't allowed to open Roth IRAs at all. Other income limits also prevent some taxpayers from deducting their IRA contributions. Still, anyone can make a nondeductible traditional IRA contribution, and even those accounts carry the tax-deferral benefits that make IRAs so powerful.
Also, it's essential to understand that once you put money in an IRA, you usually won't want to take it out before you retire. In many cases, penalties of 10% will apply to withdrawals made before age 59 1/2. Withdrawals from traditional IRAs will always boost your taxable income, potentially raising your tax bill.
Finally, one thing to keep in mind is that you can open an IRA without necessarily investing every single penny right away. Brokerage companies typically offer options for holding cash in an account, even paying interest on the money while you wait to invest it. By having the IRA already open, you'll be ready to pounce on your favorite investing opportunity whenever it arises.
Saving for retirement is important, and you owe it to yourself to be one of the few who get their financial act in order early in the year. Don't wait another day to open your IRA. As the first financial move you make in 2017, making an IRA contribution will pay rewards for the rest of your life.
The Motley Fool has a disclosure policy.