Contributing to an IRA—short for "individual retirement account" —is a great step to take on your path to retirement. With an IRA, you can invest your savings and defer taxes on any earnings until you make withdrawals down the road. No wonder 91 percent of people who have an IRA feel confident about their retirement savings, compared to 64 percent of those who don't.1
For many of us, the hardest part about saving in an IRA is getting started. With various types of IRAs to choose from, tax considerations, government jargon and rules about withdrawing your money, it can feel overwhelming. A simple description of the two main types of IRAs, along with when they may make sense for you.
Is a traditional IRA right for me?
First, let's start with the basics—traditional IRAs. Anyone with "earned income", meaning income subject to tax, can contribute to an IRA until retirement.
There is an annual limit on how much you can put in an IRA. For the 2020 tax year, you're allowed to contribute up to $6,000 to a traditional IRA—and the deadline for getting the money into the account is tax day of the following year.
If you're at least 50 years old, you can invest even more: Starting the year you turn 50 and every year after that, you can make what's called a "catch-up contribution". For the 2020 tax year, people who are at least 50 can contribute an additional $1,000, meaning the most you could contribute altogether would be $7,000.
Here's the deal with taxes: Your contributions may or may not be tax deductible. It depends on whether you or your spouse are covered by a workplace retirement plan, and also whether your income exceeds certain amounts.
But even if you don't get a tax break upfront, there's still a potential tax advantage: Any earnings on the investments inside your traditional IRA are protected from taxes until you start taking money out. In other words, your investments can grow tax free as long as they stay inside the IRA.
So, when and how can you get to your IRA savings? These accounts are meant for retirement, so if you make a withdrawal before you turn 59½ years old, there's a 10% penalty, plus the tax due on any tax-deferred contributions and earnings.
But once you reach the year of that half birthday, you can start making withdrawals with no penalty. Keep in mind, though, that you will owe any tax due.
Starting no later than April 1 of the year after you turn 72 (as of January 1, 2020), you no longer have a choice: You have to start taking what are known as "required minimum distributions", or RMDs. (So, if you turn 72 in 2020, you would have to take your first RMD by April 1, 2021). The IRS could assess penalties if you don't start on time.