Slightly less than 60% of American workers don't have a retirement plan through work, according to a recent report by the Aspen Institute Financial Security Program and Common Wealth. That's 55 million people.
Partly, these figures are driven by the increasing number of contract and contingent positions in the workplace. Currently, 20% of working Americans are in contract positions and more than 50% of them don't have benefits, including a retirement plan through work, according to an NPR/Marist poll.
Contract, contingent, and freelance positions are expected to rise in the future, too. They may account for half of U.S. jobs within the next decade. But people who have worked for smaller companies, have low to moderate income, and changed jobs frequently are also more likely to be without a workplace retirement plan.
If you're one of the people without a plan at work, saving for retirement might seem out of reach. And that could have serious repercussions on your future. But there's a retirement savings vehicle that can be opened by anyone, no matter whether they're working or not and no matter what their income is. It's the Individual Retirement Account (IRA). Here's everything you need to know about them.
What's an IRA?
IRAs are self-directed retirement accounts that anyone with earned income from a job or self-employment can open. Banks, credit unions, and brokerage companies all offer IRAs.
There is an upper limit on how much you can contribute each year, set by the Internal Revenue Service (IRS). For 2019, it's $6,000 ($7,000 if you're 50 or over, to allow you to boost your retirement savings).
One of the advantages of IRAs is their potential to increase your money over time. Through the power of compounding, money invested can grow way beyond your initial contribution. If you start when you're 30 years old, for example, and contribute $2,000 each year until you're 67, you'll save roughly $74,000. But the money can grow to almost $376,000, assuming a stock market return of 7% annually, which has been the historical average.
Types of IRAs
There are two types of IRAs, traditional and Roth. When you open an IRA, you'll have to choose which type you want. There are pros and cons to each.
Contributions to a traditional IRA are tax deductible in the tax year for which you contribute. For example, if you have an income of $35,000 and contribute $2,000 to a traditional IRA, you can deduct the $2,000 from your income on your tax return. You'll then just pay income tax on $33,000.
The contributions and amounts in a traditional IRA grow on a tax-deferred basis, including any capital gains. But the amount will be taxed when you withdraw it, at the existing tax rate for your income at that time. You must take a required minimum distribution (RMD) from a traditional IRA account once you reach 70 1/2, and you can start taking them at 59 1/2 without penalty if you wish.
Roth IRAs give you no immediate tax deduction. If you make an income of $35,000 and contribute $2,000 to a Roth IRA, you can't deduct the $2,000. But, like traditional IRAs, the money in a Roth IRA, including capital gains, grows tax-free. Then, unlike with a traditional IRA, your withdrawals from a Roth IRA are not taxed. So if you have $300,000-plus when you want to withdraw money from your Roth IRA, you won't pay taxes on the amount you take.
You can withdraw Roth IRA money without penalty as long as you're 59 1/2 and have had the money in the account for at least five years. Roth IRAs never have RMDs; you can leave the money in the account as long as you wish.
In choosing between a traditional and Roth IRA, you have to decide whether you'd rather have the tax advantage now or later, when you retire.
Choosing what to invest in
Because IRAs are self-directed, you can choose what to invest in. While there are many different asset classes investors can choose from, the two primary ones are stocks (mutual funds and individual companies) and fixed income (bonds and certificates of deposit, or CDs).
Each of these two asset classes have pros and cons. On average, stocks have had better returns than fixed income over time, and that's a big pro. But stocks are a more volatile investment class.
But declining stock markets have historically been more than counterbalanced by rising markets over time. That's why the historical average is a gain of 7%, which includes both down and up years. It's important to think long term when you're thinking about retirement and not just focus on one year's worth of returns.
Fixed-income assets have historically had lower returns than stocks. But bonds and CDs have a significant pro that stocks don't have: their prices and yields (returns) are much more stable. They help you manage the risk of a fluctuating stock market.
To decide what the mix should be, some financial professionals suggest subtracting your age from 110 to determine the percentage you should place in stocks. The remainder goes to fixed income. So if you're 30, you can place 80% of your IRA investment in stocks and 20% in fixed income. That sets you up nicely to see strong returns with stability.
Take a look at IRAs
IRAs can be a great way to save for retirement. Especially if your workplace doesn't give you a retirement plan account of its own, an IRA gives you the flexibility to save and invest for your long-term financial goals.