What is an IRA and Why do You Need One?
IRA stands for Individual Retirement Arrangement. IRA accounts, also known as IRAs, are a way for you to provide for yourself in your retirement.
To understand IRAs, it's important to understand contributions, earnings, and distributions.
1. What is an IRA Contribution?
This is what a person deposits into their IRA. You can fund an IRA with cash, a check or a direct transfer (one time or recurring) from your bank or another retirement account. It can also be through a payroll deduction if your employer sponsors an IRA-based retirement plan. Both Traditional and Roth IRAs have annual contribution limits. Roth IRA contribution limits are based on your modified adjusted gross income, depending on your tax filing status. Traditional IRA contributions are not limited by annual income.
2. What are IRA Earnings?
If you or your spouse have earned income that meets the IRS requirements, you can set up an IRA with a bank or a brokerage firm. If the income comes from employment, it’s earned income. Social security, investments, alimony, and child support are not considered earned income.
Retirement funds can be invested in deposits with Huntington Bank (MMA & CDs) and/or with our affiliate Huntington Financial Advisors which offers retirement advice and a wide array of investment product options, along with planning insight and advice that's tailored to help meet each client's specific situation. For more information about how a Huntington Financial Advisor can help you, contact your banker.
3. What is an IRA Distribution?
This is money that you take out of your IRA. Typically, people take distributions during their retirement. There are special situations where you can withdraw money before retirement, but there may be early withdrawal fees and tax penalties. You will want to contact a tax professional before you take this action.
So, who can benefit from establishing an IRA?
Anyone who wants to save more for their retirement may want to open an IRA, but there are specific circumstances that may make a Bank IRA an especially appealing option:
- Your employer does not offer a 401(k) plan and you would like to begin saving for retirement.
- You participate in your employers retirement plan, but want to save more. Opening an IRA to save for retirement may also be beneficial thanks to the power of interest compounding and tax advantages.
- You may already have IRA deposits at other financial institutions that are earning lower rates (either liquid Savings/Money Market or a soon maturing CD IRA). You can take advantage of this opportunity to consolidate retirement deposits to maximize earnings based upon a competitive interest rate Huntington Bank offers.
- For someone who is close to retirement and/or risk averse, the Money Market Cash IRA could be a solution to leverage the FDIC insurance coverage up to your applicable limits.
If you already participate in a 401(k) plan or other employer-sponsored retirement plan, could you benefit from an IRA too?
401(k) and IRAs are both ways to save for retirement. If you have a 401(k), you can also have an IRA. They work differently to help you in your retirement years.
401(k) plans are employer-sponsored plans that allow for employee and employer contributions. An employer may apply a vesting schedule to employer contributions meaning that the employee's right to retain the contributions is earned over a specified number of years during which the employee must remain employed.
Traditional and Roth IRAs are set up independent of your employer and you usually have a wide range of options to choose from. You don’t get employer matching funds, but you can tailor your portfolio to match your goals and risk-level. IRAs have a lower contribution limit than 401(k)s.
Should you have both an IRA and 401(k)?
There are limits to how much money you can contribute to a 401(k) and an IRA. 401(k)s have higher limits than IRAs. The limits are independent of each other. This means you can max out your contributions to a 401(k) and an IRA to save more money for retirement. If you’re concerned that you’re not saving enough for retirement, you should consider setting up an IRA account.
Types of IRAs
There are a variety of IRAs, but most people will take advantage of the two main types of IRAs: Traditional IRA and Roth IRA. Keep in mind that there are tax implications for the different types of IRAs. Consult a tax professional for advice on how taxes affect retirement planning.
IRA Contribution Limits
Every year, the IRS sets the contribution limits for IRAs. Roth IRAs and Traditional IRAs have the same limits. visit www.irs.gov to learn more about annual limits.
The IRS also imposes income limits for contributing to a Roth IRA and the income limits for taking a tax deduction based upon contributions to a Traditional IRA.
Distributions from both Roth IRAs and Traditional IRAs may be taken penalty free at 59 ½ years of age.
IRA Required Minimum Distribution
If you have a Traditional IRA, you’re required to start taking required minimum distributions (RMDs) after you turn a certain age. The recently enacted Setting Every Community Up for Retirement Enhancement Act (the “SECURE Act”) pushes back the age at which you need to start taking your (RMDs). Traditional IRA owners will now be able to wait until they turn 72 to begin RMDs, rather than 70 ½. (This provision only applies to persons who attain age 70 ½ after December 31, 2019). The IRS has a worksheet to help you calculate what your RMD will be. The IRS may impose a 50% excise tax on the amount not distributed as required. Since many people start retirement in their 60s, this may not be a big worry. Consult a tax professional if you have questions or concerns about how the SECURE ACT may impact your retirement planning.
Roth IRA Account
Contributions to a Roth IRA come out of post-tax dollars and are not deductible. The biggest difference between a Roth IRA and a Traditional IRA is when you pay the taxes. With a Roth IRA, the taxes are paid during wage-earning years. When you reach retirement, qualified distributions (including earnings) are tax free. A qualified distribution is one made at least 5 years after you set up and contribute to your Roth IRA and on or after age 59 ½, your death or disability. With a Roth IRA, you can withdraw your contributions at any time without paying early withdrawal penalties, but bank penalties may still apply.
Additionally, contribution caps are income dependent for a Roth IRA. To learn more about contribution please visit www.irs.gov. Roth IRAs also have an overall income limit. If a person earns $139,000 or more (single and head of household in 2020), they cannot participate in a Roth IRA.
Here’s a summary of the features of a Roth IRA:
- Contributions from post-tax dollars
- Contributions can be withdrawn at any time tax free (bank penalties may still apply)
- Earnings may be withdrawn tax free on or after age 59 ½ and after a five-year initial period. Distributions can begin at age 59 ½
- Penalties may apply for withdrawing earnings before age 59 ½ Income based contribution limits
- No RMD until death
- Income based contribution limits
- Income based participation limits
- Max annual contribution: $6,000 ($7,000 if over 50) for 2020, as updated from time to time by the IRS for cost of living adjustments
Traditional IRA Account
Contributions toward a Traditional IRA are paid with pre-tax dollars. Taxes are paid upon distributions. There are penalties for withdrawing contributions prior to the age of 59 ½ with certain exceptions. There are no income limits to participate in a Traditional IRA and the contribution amount is not limited by income; however, the amount of the contribution that can be deducted from taxes is income dependent. In 2020, if you are covered by a retirement plan at work, a single person who files as head of household earning $65,000 or less can take a full deduction. If that same person made $75,000 or more, they would not be able to take any deduction. If you are not covered by a retirement plan at work, your contribution is deductible in full.
Here’s a summary of the features for a Traditional IRA:
- Contributions from pre-tax dollars
- Distributions are taxed
- Earnings are taxed
- Penalties may apply if withdrawing contributions before age 59 ½
- RMD at age 70 ½, if the owner reached age 70 ½ on or before December 31, 2019, or age 72 if the owner reaches age 70 ½ after December 31, 2019
- No income-based contribution limits
- Income-based tax deductions for contributions
- Max contribution: $6,000 per year ($7,000 if over 50) for 2020, as updated from time to time by the IRS for cost of living adjustments
Everyone’s current financial situation and goals are different. Talk to your tax advisor about potential tax considerations.
Early Withdrawal Penalties
What are the penalties for early withdrawal from an IRA? If you withdraw money out of your Traditional IRA before the age of 59 ½ there may be a 10% tax penalty associated with it unless an exception applies such as qualified higher education expenses, qualified first-time home buyer (up to $10,000) and certain unreimbursed medical expenses, among others.
As mentioned under the Roth IRA section of this article, there are no IRS penalties for withdrawing contributions to a Roth IRA. There are penalties for taking an early withdrawal of the earnings.
Money Market Account IRA vs Fixed-Rate IRA CD
Risk-averse investors and people who are close to retirement age may want more conservative investments. Bank Money Market IRAs and Fixed-Rate IRA CDs (Certificates of Deposit) can be part of a conservative portfolio. Money Market IRAs and Fixed-Rate IRA CDs function similarly to their non-IRA versions with a few important differences. Both Traditional and Roth IRA Plans can have Money Market Accounts or CDs in the portfolio.
Like the non-IRA version, Money Market IRAs and Fixed-Rate IRA CDS are FDIC-insured. Money Market IRAs have a variable interest rate while Fixed-Rate IRA CDs have a fixed interest rate up to applicable limits.
Differing from their non-IRA counterparts, there are penalties for withdrawing the funds before the age of 59 ½. With a Money Market Cash IRA, the original investment earns interest over time and you can make deposits at any time. With a Fixed-Rate IRA CD the principle and earnings are automatically reinvested when the CD reaches the maturity date, unless customer would like to renegotiate the CD terms during the grace period. You don’t make additional deposits after opening the account, except during the grace period of 10 days after any maturity date. A Money Market Cash IRA with Huntington can be started with as little as $1. A Fixed-Fate IRA CD can be started with Huntington with $1,000. We have more information about Money Market IRAs if you’re trying to decide if it’s a good way to diversify your portfolio.
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