What is an IRA and when should I open one? The individual retirement account, (IRA) became popular decades ago when average Americans wanted to be more hands-on with their retirement savings. The two most popular versions, traditional and ROTH, both offer savings in a tax-advantaged account. But the common question many of us have is, “when should I open an IRA?”
Start saving for retirement early
Retirement may seem a long way off, but in short, investing early is always a good idea. Naturally some want to wait before parting with their hard-earned money for a retirement they view as being far down the road, but starting early can really add up to a comfortable retirement.
What’s the best type of IRA for me?
Traditional IRAs allow you to contribute to the fund before it is taxed by the government. It will however be taxed once you withdraw the funds in retirement. If you are in a high tax bracket, a traditional IRA allows you to invest money that would normally be taxed, keeping the funds in your portfolio, earning interest and deferring taxes until retirement when you’re presumably in a lower tax bracket.
A contribution to a Roth IRA is made after you pay taxes, making it better for individuals in lower tax brackets, and by extension, a better option if you are starting at a younger age. A Roth IRA provides flexibility, allowing you to withdraw your contributions early if needed without tax consequences. However, you cannot withdraw any earnings.
You might think of the Roth IRA as only a retirement vehicle, but Roth IRAs can be used for both college expenses and retirement income. While receiving no initial tax deductions, the accounts grow tax deferred and are actually exempt from withdrawal penalties if the funds are used specifically for higher education.
Simplified Employee Pension (SEP) Plan is an IRA based retirement vehicle established by employers, including self-employed individuals, allowing for tax-deductible contributions. Taxes are paid upon withdrawal at retirement.
Opening an IRA allows you to take advantage of compounding interest
For most, the sooner you start saving for retirement the better. Compounding interest accumulates over time building your nest egg over the years. The longer it has, the bigger the return.
When not to open an IRA
Securing your future is important, however, it wouldn’t make sense to go into debt now to save for tomorrow. If you have the extra cash, it’s a smart idea. If not, wait until you do. Also, if your employer has a 401K, it might make more sense to take advantage of a matched vehicle rather than an individual plan.