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It’s never too early to start saving for retirement, and there are lots of great resources available to help you achieve your financial goals. One option to consider is an Individual Retirement Account, or IRA.

What’s an IRA?

IRAs are tax-advantaged savings accounts specifically designed to help you save for retirement.

Unlike other retirement plans, such as 401(k)s, IRAs can be opened without an employer if you have taxable compensation. Taxable compensation mostly means any income that you earn for work.

There are three main benefits of using an IRA for retirement savings:

  • Flexibility: When you contribute money to your IRA, you choose exactly the types of investments you want to help meet your retirement savings goals. Other employer-sponsored plans, such as 401(k)s, typically offer specific investments. Plus, since IRAs are not employer-sponsored, you don’t have to worry about rolling over your plan if you change jobs.
  • Earning investment gains: If your investments gain positive returns, the money in your IRA is subject to increase. However, it is important to keep in mind that there is always the possibility of experiencing losses with invested funds as well as fees and charges associated with them.
  • Benefiting from tax advantages: Depending on the type of IRA you open, you may experience a variety of tax advantages, including a reduction in your taxable income for contributed funds, or tax-free qualified withdrawals.

What are my IRA options?

The two most common types of IRAs are Traditional and Roth. Traditional IRAs generally offer more tax advantages upfront since contributions may be tax deductible.

On the other hand, Roth IRAs generally offer more tax advantages in retirement since qualified withdrawals are tax-free.

Traditional IRAs

  • Contributions: You (or your spouse, if you file taxes jointly) may contribute at any age, if your income falls below a yearly amount set by the IRS. Contribution limits are subject to change, but in 2022 you may contribute up to $6,000 in total to all your IRA plans combined. The limit is $7,000 if you’ll be age 50 or older by the end of the year.
  • Withdrawals: Withdrawals of investment gains are taxable. You may withdraw money anytime and at any age. However, if you are under 59 1/2, you may have to pay an additional 10% tax.
  • Taxes: You may be able to deduct contributions, but this depends on two main factors — whether you already have a retirement plan at work, and your income. Check with the IRS or a tax professional.
  • Distributions: You are required to take at least the minimum distribution amount after you turn 72.

Roth IRAs

  • Contributions: You (or your spouse, if you file taxes jointly) may contribute at any age, as long as your income falls below a yearly amount set by the IRS. Contribution limits are subject to change, but in 2022 you may contribute up to $6,000 in total to all your IRA plans combined. The limit is $7,000 if you’ll be age 50 or older by the end of the year.
  • Withdrawals: Withdrawals of investment gains are generally not taxable. However, if you are under 59 1/2, you may have to pay a 10% tax.
  • Taxes: Contributions are not deductible from your taxable income. However, you are allowed to make qualified withdrawals tax free because you pay taxes at the time of contribution.
  • Distributions: You’re not required to take distributions as long as you are alive.

It’s important to review the details of each type of IRA before you commit. Keep in mind that the fees associated with managing IRAs differ by provider, so you should also use that as one deciding factor when making your decision.

How do I open an IRA?

If you decide that an IRA is the right choice for you, it’s time to learn the steps needed to open your account.

  • Determine your savings goals and your eligibility. Your goals and eligibility guide the types of investing tools you may choose. Before you try to open an IRA, make sure your income and retirement plans are aligned with this option.
  • Find a trusted provider and determine if they are right for you. Since you are responsible for selecting the provider of your IRA, it is extremely important that you do your research before committing. Be sure to consider the fees associated with your account, and the investment options offered by the provider. You should also use BrokerCheck, a free tool offered by the Financial Industry Regulatory Authority (FINRA) that may help you research the background and experience of financial brokers, advisers, and firms.
  • Fill out paperwork manually or online. Depending on your provider and your comfort level, you will then need to fill out the documentation needed to open your IRA.
  • Designate a beneficiary. When you open an IRA, select a person(s) or entity to receive any money in your account if you die. You can usually select multiple beneficiaries and designate what percentage of your account each would be entitled to.
  • Choose your investments. There are a variety of ways to invest your money. The most essential thing is that you choose the right mix and types of investments to help meet your individual goals.
  • Set up contributions. When you set up your account, you may also set up monthly or annual contributions. Behavioral economics research shows that making contributions automatically is an effective way to save regularly and consistently.
  • Monitor your account. Check your account at least once a year. Use end-of-year statements to monitor your fund performance and determine if your investing goals are being met.

How will my funds be invested?

Once you have contributed money to an IRA, you designate how your funds will be invested. Some investments carry more risk than others — understanding your personal level of risk tolerance is key to diversifying your investment choices to manage risk.

  • Mutual Funds: A mutual fund is a company that pools money from many investors and puts that money into a mix of securities such as stocks, bonds, and short-term debt. The mix of securities is known as the fund’s portfolio, which can be made riskier or safer depending on what investments are chosen.
  • Company Stock: Investing in stocks gives you a share of ownership in a company. While stock returns offer the greatest potential for growth, their value can go up or down drastically.
  • Bonds: Buying a bond means lending to the issuer, which may be a government, municipality, or corporation. In return, the issuer promises to pay you a specified rate of interest on top of the original amount, the principal. Bonds typically provide predictable and steady streams of returns; however, they also have some risk.
  • Variable Annuities: A variable annuity is a contract between you and an insurance company that provides consistent income, generated from investments. These arrangements can be complicated, and the mix of investments can vary greatly, so understand the product you are buying before choosing.
  • Index Funds: Index funds are like mutual funds but have a portfolio that closely follows a particular market index such as the S&P 500. Keep in mind that returns can vary widely depending on the chosen index, so understand the product fully before investing.

An option that your plan may offer is a target-date retirement fund, which is a portfolio made up of different types of investments all set to mature by a specific year. Your fund manager oversees the portfolio and communicates the perceived risk level to you based on the types of investments selected.

How much should I save for retirement?

Assume you’ll need 80% of your current annual income each year that you are retired, and that you will be retired for 30 years. You can estimate your retirement needs in a few simple steps.

Key points

There are lots of important considerations to think about when deciding if an IRA is the right choice for you to reach your retirement savings goals. Here are a few key points to keep in mind.

  1. Compare types: The two main types of IRAs are Traditional and Roth. While both share certain benefits, there are key differences you should keep in mind.
  2. Set goals: You need to know how much you should be aiming to save before selecting a retirement savings plan. Take the time to determine your savings goals, and then select plan and investment options that may help you get there.
  3. Save early and save often: Interest and investment gains have the potential to make up a significant portion of your savings, but you should try to save as early and as often as possible to get the full benefits of interest compounding.

Next steps

  • Set retirement goals: It’s important to know how much you need to save to reach your goals before you commit to a plan. This means evaluating the lifestyle and age at which you want to retire and calculating how much you need to save to get there. 
  • Determine your eligibility: Factors such as income, age, and taxes will impact the plans you make for retirement savings. Be sure to carefully research the eligibility requirements for an IRA before you include it in your plans.
  • Research providers: Because these plans are not employer-provided, you will need to go into the market and buy an IRA from a provider of your choosing. Be sure to thoroughly research your broker and compare fees before committing to an IRA.

The information in this article was obtained from various sources not associated with Adirondack Bank. While we believe it to be reliable and accurate, we do not warrant the accuracy or reliability of the information. Adirondack Bank is not responsible for, and does not endorse or approve, either implicitly or explicitly, the information provided or the content of any third-party sites that might be hyperlinked from this page. The information is not intended to replace manuals, instructions or information provided by a manufacturer or the advice of a qualified professional, or to affect coverage under any applicable insurance policy. These suggestions are not a complete list of every loss control measure. Adirondack Bank makes no guarantees of results from use of this information.

Investment and Insurance products are not deposits, are not FDIC Insured, are not guaranteed by the Bank, may go down in value, are not insured by any Federal Government Agency, and are not a condition to any banking service or activity.

Article written by EVERFI