Here's Why You Shouldn't Only Invest in an IRA

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IRAs offer plenty of benefits -- but they shouldn't be your only investment account.

Key points

  • IRAs offer different tax benefits that make it easier to save for retirement.
  • Since IRAs are pretty restrictive, it's a good idea to invest some of your money outside of one.

There's a reason workers are strongly advised to save for retirement throughout their careers. Once you stop working, you'll generally be entitled to Social Security benefits. But those benefits will only replace about 40% of your pre-retirement paycheck if you're an average earner.

Meanwhile, seniors are generally told to aim for 70% to 80% of their former earnings to maintain the lifestyles they're used to. And so if you don't save on your own for retirement, you might struggle financially or end up being forced to make sacrifices you'd rather not deal with later in life.

Now if you work for a company with a 401(k), you can use that as your retirement savings plan. If you don't have access to a 401(k), you can always open an IRA instead.

IRAs offer a host of tax benefits, so it's worth funding one consistently. But here's why you may not want to put all of your investment dollars into an IRA.

IRAs have many restrictions

With a traditional IRA, the money you contribute goes in on a tax-free basis. If you put $5,000 into a traditional IRA, that's money the IRS can't tax you on, as long as you’re below the income limits.

Plus, as you invest your IRA and it earns money through investment gains, you don't incur yearly taxes on those gains. Rather, those taxes are deferred until the time comes to take withdrawals during retirement.

But because IRAs offer a host of tax benefits, they also come with specific rules. For one thing, you can't remove funds from an IRA prior to age 59 1/2 unless you qualify for an exception. If you withdraw funds early, you'll be charged a 10% penalty on the sum you remove. Take a $5,000 withdrawal to cover an emergency expense, and you'll be looking at throwing $500 of your hard-earned money away.

That's why you may want to invest some of your money outside of an IRA. You’ll have more flexibility on how to use those funds.

Let's imagine you want to start a business at age 40 and aren't seeing any affordable loan options to get that venture off the ground. If you have $200,000 in your IRA, that makes for a frustrating situation because you have a pile of cash that's yours, only you're not allowed to access it without penalty. If you have money in a regular brokerage account, you can take a withdrawal for any reason.

Now if you withdraw funds from a regular brokerage account and cash out investments at a profit, you'll be charged capital gains taxes. But that's not the same thing as a penalty. And it's not really different from the taxes you'll pay on gains in your IRA.

Striking a balance

IRAs have annual contribution limits that change from year to year. This year, you can put up to $6,000 into an IRA if you're under 50 years old, or $7,000 a year if you're 50 and over.

Due to the tax breaks involved, it pays to max out your IRA and then put some additional money into a regular brokerage account. But if you can't swing that, then you may need to work on striking a balance. If you have $4,000 a year you can part with, for example, you may decide to put $3,000 into your IRA and $1,000 into a regular brokerage account.

IRAs really are a wonderful savings tool. But it also pays to give yourself access to some unrestricted money.

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