Is an IRA Right for You?

When it comes to retirement, you need to sock enough money away for a comfortable future. But there's also the here and now to consider. Individual retirement accounts (IRAs) are savings vehicles that can help you build wealth for retirement and potentially get tax breaks, either up front or in the future. There are two main types of IRAs to consider:

• Traditional IRA: Can allow you to make pre-tax contributions and defer the taxes you owe until you withdraw the money after age 59½. Withdrawals in retirement are taxed as ordinary income; however, if you make any withdrawals prior to age 59½, you may be subject to a 10% federal tax penalty.
• Roth IRA: Contributions are made with after-tax dollars, so you pay taxes up front. But your money can potentially continue to grow tax-free, and withdrawals are tax-free after age 59½ if you've had the account for at least five years. If you take a distribution of Roth IRA earnings before you reach age 59½ and before the account is five years old, the earnings may be subject to taxes and a 10% federal tax penalty.

Whether either IRA is right for you, or both, depends on your specific situation and goals. Here are five common scenarios in which an IRA could be a good option for you.

Employer-sponsored 401(k) plans are called the backbone of retirement savings for two reasons:

1. Most employers offer some form of match on employee 401(k) contributions—that's free money you shouldn't pass up.
2. 401(k)s have generous contribution limits that usually come out of your paycheck on a pre-tax basis ($23,000 for tax year 2024 and $23,500 for tax year 2025, plus a $7,500 catch-up if you're 50 or older. Also, starting in 2025, if you're 60 to 63, you can contribute an additional $11,250, a new super catch-up contribution introduced by the SECURE 2.0 Act.)

But what if you don't have access to a 401(k) through your employer? In that case, your next best option could be a tax-advantaged IRA. In 2024 and 2025, you could contribute up to $7,000 to a traditional IRA (plus a $1,000 catch-up if you're 50 or over).

If you're self-employed, you can also consider another type of IRA called a SIMPLE IRA or SEP-IRA. These plans allow small business owners to set aside much more for retirement than a regular traditional IRA will allow.

Whether you're saving in a regular traditional IRA, a Roth IRA, or other IRA, the tax advantages of these accounts can potentially put you ahead of where you'd be if you only put money in a taxable account. However, we recommend speaking with your tax advisor to see which choice better fits your personal situation.

Even if you have a 401(k), an IRA might still make sense if you want to set aside more than your 401(k) allows. In that case, a traditional or Roth IRA could help you save even more. Speak to a tax advisor before enrolling to see if you're eligible to make contributions.

With an IRA, you may also have access to a wider range of investment options, including stocks, bonds, exchange-traded funds (ETFs), mutual funds, certificates of deposit (CD), and more. By comparison, most 401(k)s generally include only a limited set of investment funds.

Contributing to a traditional IRA is one of only a few tax-smart moves you can make right up until Tax Day. As long as you open and fund your account before the IRS filing deadline, your eligible tax-deferred contributions can be subtracted from your taxable income. And that might be enough to drop you into a lower tax bracket, reducing what you owe at tax time. However, there are some rules to be aware of when it comes to determining if your contributions will be tax deductible based on your income level and if you or your spouse is covered by an employer plan.

On the other hand, if you don't need the tax break now, you might prefer to contribute to a Roth IRA to take advantage of the potential tax-free growth and tax-free withdrawals. Your contributions will be made with after-tax dollars, so they won't reduce your taxable income now. But your money can potentially grow tax-free, which can provide tax savings when you start making withdrawals in retirement. 

In addition, if you pass your Roth IRA onto your heirs, their withdrawals will also be income-tax free, making them a tax-efficient way to transfer wealth from one generation to the next.

There are income limitations when it comes to contributing to a Roth IRA, so be sure you check those limits before putting money into a Roth account.

Because they're each taxed differently, traditional and Roth IRAs offer unique ways to save tax efficiently, but one account is not necessarily better than the other. Having a portion of your assets in each account type can offer flexibility for your withdrawal strategy during retirement. This is often called tax diversification.

For example, let's say you have 50% of your retirement assets in a traditional IRA (pre-tax contributions) and 50% in a Roth IRA (after-tax contributions). During retirement, you can take taxable withdrawals from the traditional IRA to pay for your living expenses and if you have a large one-time expense, such as a car purchase, you could use your Roth IRA funds to make that purchase to avoid pushing yourself into a higher tax bracket.  Diversifying your retirement savings into both account types can help you manage your taxable income and how much tax you owe in retirement. Remember, speak with a tax advisor to figure out which plan could work best for you.

The decisions you make today about how you save for retirement will have a lasting impact for many years to come. That’s why we recommend meeting with a financial planner and tax advisor to help determine the most tax-efficient way to save and invest for your retirement.