How to Handle an Individual Retirement Account (IRA)
Using an Individual Retirement Arrangement (IRA) account to set aside money for the day that you no longer wish to work is a smart financial move. You can invest money in an IRA each year, and watch it grow with any applicable income taxes either deferred or eliminated, depending on the type of account. The power of compounding over many years can increase the value of the account by many times what you have contributed. In addition to helping you with retirement, an IRA can also allow you to save for a first-time home purchase or a child's college education.
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Instructions
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Start investing in an IRA account as soon as possible. The sooner you start investing, the more time the money will have to grow. If you already have an IRA, consider increasing the amount that you invest. Put your IRA investments on auto-pilot, using automatic drafts from your checking account or direct payroll deposit. Chances are you won't even miss the money, but you will notice the long-term growth and benefits.
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Select your investment choices wisely. Consider your long-term goals when choosing the investment vehicles for your account. If you are reasonably young, or it will be over five years before you need the money in your IRA, the stock market is a good investment choice. Stocks are subject to short-term volatility, meaning they can change value quickly, both increasing and decreasing, but over the long term, the stock market generally grows, outpacing the inflation rate. Mutual funds that invest in stocks are a good way to minimize the risk of single-stock investing, spreading your money over many different stocks.
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Choose between a Roth or traditional IRA. Both accounts grow without taxes, but you can take an immediate tax deduction for money that you contribute to a traditional IRA in exchange for paying taxes when you withdraw the money at retirement. With a Roth, you forego the immediate tax deduction in exchange for completely tax free withdrawals at retirement. Most people will see long-term benefits with a Roth compared to traditional IRAs. A Roth may not be available to you if you have a higher income.
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Protect an inherited IRA from excessive taxes. If you inherit an IRA from your spouse, you have more generous options for the account. You can keep the account and continue your contributions, or you can remain a beneficiary on the account. If you inherit an IRA from someone other than your spouse, such as a parent or grandparent, your choices in handling the account are more limited. You will probably need to take regular withdrawals each year depending on your own life expectancy, paying taxes on these withdrawals as regular income. You can cash out an inherited IRA in full, but this generally has severe tax implications.
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Tips & Warnings
You can open an IRA at many different types of financial institutions, from banks to brokerage firms. Consider mutual fund companies who will accept regular, automatic contributions. If you are in doubt about where to invest your contributions, seek help from a financial professional.
Consult a tax professional with complicated IRA situations, such as inherited accounts. He should be able to counsel you on ways to minimize the tax liability.
