If you’re a woman juggling multiple savings goals and stashing money away for retirement is anything other than your number one financial priority, just stop. We know your heart’s in the right place, but, sorry ladies, we simply can’t afford to financially shortchange our futures.
Women are already in a game of financial catch-up. Putting your well being second to your kids, your partner, your job, your parents won’t end well. Take to heart how more than 2,500 women across all age, income, ethnic, marital, geographic and asset levels responded to a Merrill Lynch survey question asking, “What do you wish you had done differently to feel more financially secure today?” Women’s biggest financial regret was not investing more of their money.
One of the best tools you can use to avoid regrets and close the retirement savings gap is an individual retirement account (IRA). Here’s what you need to know about the types of IRAs to pick the best ones for your situation:
What’s an IRA?
An IRA is an account individuals can open at a financial institution and use to save for retirement. They’re “individual” accounts because anyone can open one, as opposed to workplace retirement accounts (like a 401(k)) that only employees of that company are allowed to use.
IRAs come in an array of styles — traditional and Roth, spousal, SEP, SIMPLE and nondeductible types. (Spoiler alert: If you haven’t heard of the spousal IRA or SEP IRA, your world is about to change.) What they all have in common is that you get a tax break on the money in the account (either upfront when you make your contribution or on the back end on your withdrawals), and your investments aren’t taxed as they grow in the account.
One common misconception is that IRAs are themselves and investment. Au contraire. An IRA is merely a container for your cash — the same way a mixing bowl holds whatever ingredients you choose. When you open an IRA you’ll decide which investments you want to add (e.g. a dash of bonds, a healthy scoop of index mutual funds that mimic the market’s overall returns, a taste of international exposure via mutual funds that invest in overseas companies, etc.). FYI: All of the types of IRAs we outline below are set up to handle any investment you’ll need to save for retirement.
Beyond what they have in common, each type of IRA has its own rules about when and how taxes work, who is eligible to contribute, and how much you’re allowed to save. Don’t be intimidated: Below are the high points on six types of IRAs most women should be aware of.
Good to Know: IRA vs. 401(k): What’s the Difference?
This is the little black dress of IRAs — the go-to account until the newer IRA options were launched in later years. With a traditional IRA you can deduct your annual contributions (up to $6,000 in 2020, $7,000 if you’re 50 or older) from your taxable income — meaning you’re funding it with pre-tax dollars. (The amount you’re allowed to deduct is based on your income, tax filing status and whether you or your spouse have access to workplace retirement savings accounts.)
The upfront deduction can help you slip into a lower tax bracket for the year. Another tax saving bonus: Your investment earnings within the account aren’t taxed: Profits from your hot stocks are off limits from the IRS until you start withdrawing money in retirement. At that time you’ll be taxed at whatever your rate is when you pull money out of your IRA.
A traditional IRA is for you if… you’re in a high tax bracket now when the upfront deduction nets meaningful savings.
Here’s what’s great about the Roth IRA: Withdrawals in retirement are completely tax-free. Yup: Tax free, as in every single dime is yours free and clear with no interference from the IRS.
Why the generosity? Because you don’t get a deduction for your Roth IRA contributions. (You already paid Uncle Sam taxes on the money you put into the account, meaning you’re using post-tax dollars.) However, like all the other IRA types, your investments grow tax-free. And one more thing: You can withdraw your contributions — not earnings (hands off those!) — for any reason and at any time. That said, you really should adopt a hands-off policy and leave your IRA money alone so it can grow for your future needs, just sayin’.
A Roth IRA is for you if… you qualify to contribute. Eligibility is based on your income, so high earners are limited in how much money (if any) they’re allowed to contribute to a Roth IRA. If you’re eligible consider using the Roth for at least a portion of your savings for a few reasons: Tax rates are likely to be higher in the future (so tax-free withdrawals will be particularly valuable). Also, if you get into a situation where you need money before retirement, Roth early withdrawal rules are more lenient than what’s allowed with a traditional IRA.
A Roth IRA Workaround: Not eligible for a Roth? Sneak in the back door by making a back-door Roth IRA contribution.
All the ways IRAs let working folks save on taxes is all well and good. But what if you don’t have earned income (a requirement for contributing to an IRA)? If you’re married to someone who makes money, you’re in luck.
A spousal IRA provides a way for those who would normally be ineligible to contribute to an IRA — stay-at-home moms, non-working partners — gain entry simply by virtue of being married to someone who contributes to their own IRA. The deal is this: You can only contribute as much as the working spouse is allowed to (up to $6,000 in 2020 with an extra $1,000 catch-up contribution if you’re 50 or older).
A Spousal IRA is for you if… you have no earned income and your spouse is eligible to contribute to a Roth or traditional IRA or both. It doesn’t matter who contributes money to the account. But the account must be set up using the non-working spouse’s Social Security number (or tax identification number) and name, making the assets legally yours. BTW: There is no such thing as a joint IRA.
For sole proprietors or freelancers, the SEP is one huge advantage of working for yourself. Contribution limits are the highest of any type of IRA: Up to $57,000 in 2020. That’s way more than the $6,000 max the IRS lets you save in a traditional or Roth IRA and nearly three times as much corporate worker bees are allowed to save in their 401(k)s. The downside: There’s no Roth version of the SEP, so you’ll pay taxes on distributions in retirement. But… you’ll get the upfront tax deduction on your contribution, too!
There are a lot of rules about how much you can sock away in a SEP. (For example, your annual contributions can’t exceed the lesser of 25% of your compensation or $57,000.) And if you have employees, you’re required to contribute to their plans too at the same proportion of salary as you do yourself. You do get a tax deduction for your largesse.
A SEP IRA is for you if… you run a company with no employees (except yourself) or have just a few that you want to reward with a retirement plan. The high contribution limits make a SEP an excellent way to amass tax-deferred retirement funds if you’re behind in your savings.
SIMPLE stands for Savings Incentive Match Plan for Employees, but the plan is more like a 401(k) in some ways than an IRA. You’ll come across it if you work for a small company (with less than 100 employees) where you’re allowed to contribute to a SIMPLE plan via salary deferral. Or, if you’re a small business owner, you can set up a SIMPLE IRA plan for you and your employees.
The upside if you work at a company with a SIMPLE IRA retirement plan is that employers are generally required to contribute to each worker’s savings via either a match or a fixed percentage of an employee’s salary. The downside: Annual contribution limits are lower than what 401(k) workers get — $13,500 vs. $19,500 in 2020. If you’re 50 or older you can make a catch-up contribution of $3,000.
A SIMPLE IRA is for you if… that’s the workplace plan available to you. Any money your employer kicks into your account is free money! If you’re self-employed trying to decide between a SIMPLE or SEP IRA, go with the latter where contribution limits are so much higher ($57,000 vs. $13,500.) Talk to your tax pro if you have employees and are trying to decide which type of workplace retirement savings plan is best.
This IRA is the exception to the rule since, as the name suggests, it offers no tax break on the front end (on contributions) or the back end (on withdrawals). This is the IRA of last resort to those who are completely locked out of the tax-advantaged IRAs (the Roth and traditional types) because of their income.
If you get no tax break on contributions or withdrawals, why bother? Because nondeductible IRAs do retain one tax perk: Tax-deferred growth on your earnings. (Translation: You don’t have to pay any taxes on dividends or other gains on the investments growing in the account.) When you finally start taking distributions from your savings, you’ll only owe taxes on the earnings growth but not the principal — because you funded the account with money that had already been taxed.
A nondeductible IRA is for you if… you’re ineligible to contribute to any other type of IRA and have already maxed out any tax-preferred retirement accounts (e.g. 401(k), 403(b)).
Set yourself up for financial security
When it comes to retirement savings, resist the caretaker temptation — the one that makes you put your financial well being second to your kids, your partner, your job, your parents, the dog. Setting up an IRA and contributing something — anything you can afford to — isn’t a gift to your future self. It’s a necessity. Women can’t afford not to.
Note: You have until the day your taxes are due (July 15 for the 2019 tax year) to set up and fund your IRA for the previous year. But you don’t have to do it in one lump sum.
More on retirement savings:
- Where to Open an IRA
- How to Open an IRA
- Roth vs. Traditional IRA: What’s the Difference
- IRA vs. 401(k): What’s the Difference?
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