Common IRA Myths & Misunderstandings
Traditional IRAs can be a great tool for retirement savings. They can also be confusing and there are plenty of myths surrounding the rules and benefits of Traditional IRAs. So, let’s spend today busting a few of those myths!
- Myth: You can only contribute to an IRA if you have a job.
Fact: In order to contribute to an IRA, one must either have earned income or have a spouse with earned income.
- Myth: You can’t touch your money until retirement.
Fact: Distributions from an IRA prior to age 59 ½ CAN be subject to penalties. There are, however, some exceptions including, but are not limited to, first-time home buyer, disability and medical expenses, and higher education. There also exists a tool called the 72(t) distribution that allows for early withdrawals without penalty.
- Myth: IRA money is tax-free.
Fact: Money is contributed to an IRA on a tax deferred (or tax deductible) basis, meaning taxes are not paid on the money today but are instead paid upon distribution of money from the IRA. This allows the money to grow tax free over the course of its investment. Typically (but not always) individuals are in a higher tax bracket while working than they are in retirement. The tax advantages are more valuable in working years.
- Myth: An IRA is an investment.
Fact: An IRA is merely an account in which investments are held. The IRA signals to the IRS that the money inside qualifies for special tax treatment (tax deferral). Sometimes the investments we put in an IRA are different that the ones we would put in a non-qualified account, but like an individual account, a joint account, a money market account, the IRA is merely the box in which the money is invested.
- Myth: You are ineligible for a Traditional IRA if you are covered by an employer plan.
Fact: While employer plan eligibility can alter some of your benefits associated with an IRA, you don’t become ineligible. One of the immediate benefits associated with the Traditional IRA is the deductibility of contributions from your taxable income. If you have a retirement plan at work, you can still contribute up to the annual limit, BUT your contribution may not be deductible. Deductibility begins to phase out at a certain income level (it differs depending on your filing status) until the entire contribution is non-deductible. So why contribute to a Traditional IRA if contributions are not deductible? There is still the benefit of tax-deferred growth and there’s another tool called the Backdoor Roth IRA that first requires a Traditional IRA, but we will save that one for another day.
Traditional IRAs have many advantages when it comes to retirement savings. The rules and limits surrounding IRAs can feel daunting, but that’s what an advisor is for! If you think you might be interested and could benefit from a Traditional IRA (hint: nearly everyone can!), talk to an advisor. They understand the ins and outs and can partner with our tax preparer to determine what the exact benefits would be for you.
