Your primary financial goal should be to sock away enough money in a savings account to cover three to six months of essential living expenses. That way, you’ll have an emergency fund to fall back on if unplanned bills come your way or you experience a bout of job loss.
But once your emergency fund is complete, it pays to put money into a dedicated retirement account. You’ll need savings of your own during your senior years, because while Social Security will pay you something, it generally won’t provide enough income for a comfortable lifestyle.
Now you could save for retirement in a traditional brokerage account — one that doesn’t offer any tax breaks but also doesn’t come with any restrictions. But a better bet may be to put your retirement funds into an IRA.
The pros and cons of IRAs
IRAs have certain restrictions that may make them a less appealing choice. For one thing, once you put money into an IRA, you’ll risk costly penalties if you attempt to withdraw it before the age of 59 1/2. The reason for this is that the IRS wants IRAs to function as retirement plans, so it wants you to leave your money alone until you’ve reached what can be considered a reasonable retirement age.
IRAs also come with annual contribution limits that can change yearly. Right now, you can put up to $6,000 into an IRA if you’re under the age of 50. If you’re 50 or older, that limit rises to $7,000.
Despite these rules, IRAs make a lot of sense. While you do have to commit to locking your money up until age 59 1/2, the upside is getting to enjoy a host of tax breaks.
With a traditional IRA, the money you contribute may go in on a tax-free basis. What this means is that if you put $6,000 into an IRA this year, the IRS won’t tax you on that $6,000, as long as your income is below the limits. Now, let’s say you fall into the 22% tax bracket, meaning that’s the amount of tax you pay on your highest dollars of income. By contributing $6,000 to a traditional IRA, you could end up lowering your tax bill by $1,320.
Meanwhile, Roth IRAs don’t offer an immediate tax break on contributions. But your investments in your Roth IRA grow tax-free. And come retirement, your withdrawals won’t be taxed at all. Plus, if you really need to, you can withdraw contributions to a Roth IRA at any time without tax or penalty.
It pays to consider an IRA
You may not love the idea of facing penalties for tapping your IRA before age 59 1/2. But if your goal is to build a retirement nest egg, that rule might prevent you from taking withdrawals prematurely and coming up short once your career ends. And it’s hard to argue with the tax breaks IRAs have to offer.
Furthermore, if you’re held back by the contribution limits IRAs impose, you can always max out your IRA and then put whatever additional money you have into a traditional brokerage account. That way, you’ll get a tax break on some of your money, and you’ll be able to invest the remainder in a way that’s less restrictive.
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