Here’s an important life lesson you may not have been told in childhood: You will spend your entire adult working years saving for one main goal — retirement. And one type of retirement account that almost everyone has access to is an individual retirement arrangement, or IRA.
IRAs come in two main formats, the Roth and the Traditional. And while both are valuable, they each bring plenty of confusion regarding some of the rules and regulations about saving in these types of accounts. Here are five IRA myths that may be preventing you from using this valuable retirement-savings vehicle.
1. I can’t save in a workplace retirement plan and in an IRA
Even if you currently contribute to an employer-sponsored retirement account at work (such as a 401(k)), you can still direct additional funds into a Traditional or Roth IRA. (See also: 401(k) or IRA? You Need Both)
For Traditional IRAs
Anyone under age 70½ with earned income can make contributions to a Traditional IRA. But if you are covered by a workplace retirement plan, the IRS may restrict the deductibility of your contributions. For 2018, if you are covered by a workplace plan, are single, and make less than $73,000, or if you’re married, file taxes jointly, and earn less than $121,000, you can contribute to a Traditional IRA and deduct either all or a portion of your contribution.
If you are single and earn $73,000 or more, or if you are married, file taxes jointly, and earn $121,000 or more, you can still make a nondeductible contribution. When you make a nondeductible contribution to a Traditional IRA, you don’t receive an upfront tax break, but your money will still grow tax-deferred in the account.
Note: As an alternative to putting nondeductible dollars into a Traditional IRA, some advisers recommend putting this money into a brokerage account instead. That’s because even though money in a Traditional IRA grows tax-deferred, distributions are taxed at ordinary tax rates. Meanwhile, although you receive no tax break for investing in a brokerage account, you may be able to get the more favorable tax treatment on your interest and capital gains when you withdraw those funds in retirement. Having said that, this still doesn’t discount the need for an IRA. (See also: Where to Invest Your Money After You’ve Maxed Out Your Retirement Account)
For Roth IRAs
Whether or not you have a retirement plan at work has no bearing on your ability to contribute to a Roth, but the IRS does impose income limits on who can contribute directly to this type of IRA.
For 2018, if you are single and make $135,000 or more, or if you are married, file taxes jointly, and make $199,000 or more, you are prohibited from contributing directly to a Roth IRA. There is a workaround to this rule called a “Backdoor Roth,” which involves making a nondeductible contribution to a Traditional IRA, then converting that to a Roth IRA. This is a common and standard practice, but see a financial planner or tax adviser to determine the tax implications for your own specific financial situation.
2. I don’t make enough to contribute to an IRA
Every year that you earn income is an opportunity to save for retirement. The government allows you to contribute a certain amount of money each year into tax-sheltered accounts. If you miss a year, you miss saving for that year forever.
Anyone with earned income under the age of 70½ can contribute to a Traditional IRA, and anyone, regardless of age, with earned income (but within the income limits listed above) can contribute directly to a Roth IRA. Even if you are unable to contribute the maximum allowable amount, make a contribution count every single year. And remember that you have until Tax Day of the following year to make your contribution for the current year. (See also: 5 Dumb IRA Mistakes Even Smart People Make)
3. I can’t contribute to an IRA if I don’t have my own earned income
Unlike other savings accounts, IRAs must have a single owner and can never be titled as a joint account. And up until now, we’ve pointed out how the first criteria for contributing to an IRA is having your own taxable compensation. But the IRS does make an important exception to this rule for nonworking or low-income earning spouses by allowing them to piggyback off a working spouse’s record of yearly income, whereby all the same rules apply. This is called a spousal IRA. This is a smart way for a couple to continue a diligent savings routine even in a one-income household.
4. I don’t need an IRA
Let’s get this straight: Everyone needs an IRA. Whether by choice or life circumstances, everyone will retire someday. And retirement is expensive. Even if you are already covered by a workplace retirement plan, an IRA can help you capture and save much-needed excess funds that will help you get by later in life.
If you have extra cash sitting in a savings or checking account (not counting your emergency fund), you can begin transferring that money to fund an IRA. As long as you have earned income for the year, it doesn’t matter where the contribution money comes from. (See also: 6 Reasons Every Millennial Needs a Roth IRA)
5. I can’t touch my money until retirement
The whole purpose of saving for retirement involves taking a long-term view and allowing your money to grow untouched. And it’s true that when you use a tax-sheltered account to save for retirement, there will be penalties if you don’t follow all the rules. While you always have access to your own money, there are a few guidelines to keep in mind.
In general, if you are younger than 59½, any money you withdraw from a retirement account will be considered an early withdrawal subject to income tax and a 10 percent penalty. But there are important exceptions to the rule, including for medical reasons or even to pay for some higher education costs.
All direct contributions to a Roth IRA are made with after-tax money, so you always have tax-free and penalty-free access to your original contributions. Note that there are different rules for Roth conversions; but if you follow the rules, you can still gain penalty-free access to your funds after a waiting period and possibly before retirement.
Retirement is your most expensive long-term financial obligation, and you’ll need to save as much as you can for as long as you can. Don’t let myths and misconceptions steer you away from the value of an IRA.