It’s a common misconception that IRA is an investment. IRA is, in fact, a savings account (often referred to as a retirement account) that allows you to save retirement money.
If you’ve heard of traditional IRA, then you know that this basic savings plan is a great way to minimize taxes and invest in various markets.
In this article, we will be viewing some important facts you should know about traditional IRA.
There is a limit on traditional IRA contributions
You may not have known this, but there is a limit on traditional IRA contributions. For people under the age of 50, the limit is $5,500 per year, and for people who are 50 and over, the limit is $1,000. You can open an additional Roth IRA account, but the limit still applies. For example, people under 50 who invest $2,000 in a traditional IRA can only invest $3,500 in a Roth IRA account. Ultimately, there is a 6% penalty for overpaying.
Furthermore, you should know that your IRA contribution depends on your yearly income. Let’s say your annual salary is $4,200. In that case, your contributions are limited to that amount of money. On a more positive note, there is no minimum age limit for contributing.
Another great thing about this IRA is that there is a type for self-employed people, as well as for small business owners. It’s called a SEP IRA, and the contributions are capped at 25% of your income.
All in all, an IRA is a great way to get tax benefits. You just need to be careful not to exceed the contribution limit.
Spousal IRA
One of the best things about traditional IRA is that you can make contributions even if you’re unemployed. If you’re married, your spouse can contribute into spousal IRA. The only condition is that the spouses yearly income is sufficient. Spousal IRA allows contributions of $5,500 per year and an additional $5,500 per year for your spouse. Ultimately, this is a great solution if you’re currently not working, but your spouse is.
You can qualify for spousal IRA if you are legally married. If you are, you and your spouse then need to file a joint tax return.
Another thing to be mindful of is that you cannot invest your pension, investments, and social security into a traditional IRA. Furthermore, only IRA approved institutions offer a spousal IRA, which includes select credit unions, banks, and brokerage companies.
How to avoid early withdrawal penalties
In some situations, you can easily avoid the early withdrawal penalties. The standard penalty for withdrawing too early is 10% on the amount you withdraw, as well as regular taxes for that same amount.
However, you can withdraw up to $10,000 no matter how old you are if you put that money towards purchasing a home, for educational expenses, or health insurance.
Remember, these exceptions will help you avoid the penalty but not the taxes.
Investing in real estate
Yet another great thing about traditional IRA is that you can use your funds to invest in real estate. You just need to be mindful of some basic rules:
- The real estate needs to be a business property
- You cannot pay off the mortgage with traditional IRA
- You cannot buy a second home with traditional IRA
IRA for people that aren’t qualified for tax-deducted contributions
Having a non-deductable IRA contribution comes with many benefits. For example, if you have a nondeductible IRA contribution, your money can grow at a tax-free rate until you withdraw it. This applies to dividends and capital gains.
The required minimum distribution
The required minimum distribution clause ensures that people do not accumulate in their retirement accounts. If they did this, traditional IRA could turn into an inheritance.
When you reach the age of 70 and a half, you need to make regular withdrawals from your IRA account by April 1st of that year if you want to avoid penalties. You can, of course, withdraw more than the minimum. However, if you go under the minimum, the IRA will charge you a 50% penalty on the required minimum amount.
Takeaways
All in all, traditional IRA has many perks to offer. It’s a great way to get ready for retirement.
If you’re mindful of the few basic rules we’ve covered, you can really take advantage of this great savings strategy.