Despite the fact that all workers get the option to contribute to an IRA, only 33% of Americans actually have one. Because traditional IRAs offer tax-free contributions and tax-deferred growth, they're a great way to save for the future -- but those aren't the only reasons to open an IRA. Here are a few additional benefits that IRAs offer.
1. You'll get more investment choices
Many savers prefer 401(k)s to IRAs because they're easy to set up and offer higher annual contribution limits. But in the battle of IRAs versus 401(k)s, IRAs have a clear advantage when it comes to investment choices. While most 401(k)s offer only a limited number of funds to choose from, with an IRA, you have far more flexibility, and with that comes the ability to keep your fees to a minimum.
See, when you invest your retirement savings, whether in an IRA or 401(k), you'll pay some sort of fee for buying into a mutual or index fund. But keeping those fees as low as possible can save you a boatload over the life of your investments. Remember, your investment fees will generally grow proportionately to your portfolio's value. Shaving a solid 1% off your total fees will save you $10,000 on a $1 million portfolio.
But it's not just fees to think about. The more investment choices you get, the more likely you are to find options that align with your personal style -- and that's an important step toward reaching your eventual goals.
2. An IRA can help you buy a home
You've probably heard that once you put money into a traditional IRA, you can't touch it before reaching age 59 1/2. Otherwise, you'll incur a 10% penalty resulting from an early withdrawal. But while it's true that you can't pull money out of an IRA prematurely, one exception to this rule is if you need the cash to purchase a first-time home.
If you can't otherwise cover your down payment, and you're buying a home for the first time, you can withdraw up to $10,000 from your IRA to put toward that expense. Better yet, if you're married, and you and your spouse each have an IRA, you're both allowed to withdraw $10,000 for a combined total of $20,000.
Of course, you should be careful about withdrawing IRA funds to finance a home because every dollar you remove is money you won't have available in retirement. But if you've done a good job saving, your IRA can make homeownership far more attainable.
3. Your IRA can pay for college
Just as you're allowed to make penalty-free early withdrawals to pay for a first-time home, so too can you remove money early from a traditional IRA to pay for a college education. And you don't even have to be the one going to college -- you can use the money from your IRA to pay for your spouse or dependents as well. Furthermore, you can use your IRA to pay for most college-related costs, including tuition, fees, books, and room and board (provided the student in question is enrolled at least half-time).
Now, keep in mind that while you won't face a penalty for taking an early IRA withdrawal to pay for college, you will be liable for income taxes on your distribution, just as you'd be liable for taxes on withdrawals in retirement. Furthermore, as is the case with a home-related withdrawal, removing money for college purposes will leave you with less of a nest egg for retirement. That said, if you've exhausted your federal loan options and are left with no choice but to take out private loans at an exorbitant rate, you may be better off tapping your IRA, provided it's abundantly funded.
There are lots of good reasons to take advantage of an IRA, and the sooner you start funding your account, the more opportunity your money will have to grow. Workers under 50 can currently contribute up to $5,500 a year to an IRA, while workers 50 and older can contribute up to $6,500. If you were to max out the lower of these two limits for 25 years and invest at an average annual 8% return, you'd wind up with over $400,000 -- and that can go a long way toward a comfortable retirement.
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