Written by: Nathan Beardemphl
For many people, retirement savings starts, and ends, with an employer provided retirement plan (such as a 401k, 403b etc.). However, these plans bring with them contribution limits and limited amounts of investment options. What if you want to set aside additional dollars for retirement? Luckily, for those looking to expand their retirement savings plan, a helpful tool is an Individual Retirement Account or IRA. Today we’ll talk about how to start an IRA, along with some common questions about them.
What is an IRA?
An IRA, as the name suggests, is a personal retirement investment account you set up outside of work, either on your own or through your financial advisor. A 401k, 403b, 457’s etc., will be tied to an employer, meaning, if you leave that employer the account stays there (unless you proactively elect to transfer it elsewhere). IRA accounts “go with you” wherever your career takes you.
An IRA has similar tax and withdrawal rules as your typical workplace retirement plan. Traditional IRA’s are funded with pre-tax contributions and withdrawals in retirement are taxable as income. Roth IRA’s are funded with after-tax dollars and withdrawals in retirement are tax free.
You can only contribute a limited amount per year to an IRA (currently up to $6,000 per year in 2021 and 2022, plus an additional $1,000 if age 50+, and you must be 59.5 years old to access the money penalty free (special exceptions do apply).
However, there are differences regarding how IRA’s and workplace retirement plans are funded and invested. With an employer provided plan, the account is funded through payroll deductions. This is where you will see a percentage, say 5% of your paycheck diverted into your employer retirement plan. IRAs, since they are individual accounts, typically cannot be funded through payroll deductions. Instead, they are funded through cash in your checking or savings account.
Once funded, there are differences as well. Employer provided plans will generally automatically invest your contributions into a pre-determined investment (a target date fund is a popular automatic selection). IRAs are not automatically invested, and you must select the funds you would like to invest in. This is important as we do not want our contributions to be sitting in cash within the account.
Another distinction on the investment front is the investment selection. Employer plans typically have a limited number of investment options to choose from (10-20 funds) if you want something other than the default option.
IRAs, on the other hand, can invest in a much wider selection of investments. Depending on where you set up the IRA, you could invest in just about any fund on the market. This is one reason rolling over, or converting, old retirement accounts into an IRA can be attractive.
How To Start an IRA
Now that we know the basics of IRAs and how they differ from an employer provided retirement plans, how do you start an IRA?
To answer this question, it will come down to whether you want professional help in managing the account. If professional management would be preferred, you can start an IRA through a financial advisor.
If going through a financial advisor, we encourage people to work with an independent financial advisor (or independent financial advising company). Being independent means their firm does not manufacture any of their own investments. Nor do any companies they may be affiliated with.
Why this is important, is that if you are seeking management from a propriety firm, that will likely result in that advisor recommending their own company’s products, regardless of whether or not it is best for your situation.
If you are more of the D.I.Y type and would like to set up an IRA on your own, you can start an IRA through almost any retail investment company. Through one of those companies, you can open an account, link it to your bank account, transfer funds, and then select the investments that align with your investment goals and risk tolerance.
Income Limits on IRA Contributions
For direct contributions into a Roth IRA, there is an income limit. If you are single and earn over $129,000 a year or are married filing jointly the income limit is $204,000 a year for 2022 ($125k & $198k respectively for 2021). If your income falls above these income thresholds, then you cannot fully fund a Roth IRA through a direct contribution.
Once you are single and earn over $144,000 or married filing jointly and earn over $214,000 for year 2022 ($140k & $208k for 2021), then you are disallowed from making direct contributions into a Roth IRA all together. Don’t complain to your friends who are still eligible – they won’t like you. However, there is a strategy commonly called the Backdoor Roth IRA that high income earners can utilize to still get money into Roth IRA’s.
With proposed legislation from Congress, there is a chance the Backdoor Roth IRA will be disallowed in 2022, so double check if that is still a viable option after you read this.
For Traditional IRA’s, if you have access to a pre-tax retirement plan through work, you can only fully deduct your contribution to a Traditional IRA if your income is under $68,000 if single and $109,000 if married filing jointly in 2022 ($66k & $105k respectively in 2021). If married and one spouse has access to a pre-tax retirement account at work, the other spouse can deduct contributions if household income is below $204,000 in 2022 ($198k in 2021). These figures are based on modified adjusted gross income.
One could argue, if you’re under those income limits for taking a tax deduction on a Traditional IRA contribution, you’re probably better off contributing to a Roth IRA. You’re in one of the lower tax brackets currently, so you aren’t in dire need of tax deductions today. May as well fund a Roth account that can be accessed tax free in the future instead. Each circumstance is unique though.
A few common questions we get asked on IRAs are below:
1. Can You Have Multiple IRAs?
Yes! You can have multiple traditional and Roth IRAs at the same time. However, the annual cash contribution limit cannot exceed the current yearly limit of $6,000 (as of 2022) between all IRAs.
How many IRA’s can you have? There is really no limit, but there aren’t too many reasons to have more than one of each type. The more you have, the more accounts you have to keep track of.
2. Can You Have Both a Roth and Traditional IRA?
This ties into the previous question, but the short answer is yes! If your Adjusted Gross Income (AGI), is too high and you are utilizing the backdoor conversion strategy to fund a Roth IRA, you will also need to have a Traditional IRA open.
3. When is the Deadline to Contribute to an IRA?
You have until the tax filing deadline to fund your IRA for the year, which is typically April 15th.
4. Can You Fund an IRA with Anything Other Than Cash?
Your regular, yearly contributions to your IRA will need to be made in cash from your checking or savings account. If you would like to get more money into your IRA than the current annual contribution limit, you can roll over or convert old retirement accounts. The $6,000 yearly limit only refers to contributions, but there is no limit on the amount you can rollover or convert from another plan. As an example, you could make a $6k contribution into your IRA for 2022 and rollover an additional $50k from an old 401k/403b too.
*Dependent upon the tax status of your employer plan and IRA, there may be taxes involved when consolidating an account into your IRA. Be sure to consult an advisor or tax professional.
5. I Own My Own Business/Practice, Can I Set up an IRA for Myself and Employees?
Yes, a simplified employee pension (SEP) IRA can be established by an employer, or someone who is self-employed. A SIMPLE IRA is a common one for a business or practice with a handful of employees.
For more details on SEP IRA plans for sole proprietors, check out another blog post on the subject: https://thefinitygroup.com/blog/solo-401k-vs-sep-ira
IRAs are a great tool for those looking to expand their savings plan. Although similar to employer provided plans with the tax benefits they provide, the process through which an account is set up, managed, and invested are distinctly different. IRA’s are a great way to save addition dollars in a tax-favorable manner.
If you are wondering how to start an IRA, you can seek professional help through a financial advisor or set up an account on your own. In either scenario, be sure to research the company you are going with. Happy savings!
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Consult with a tax professional for specifics pertaining to your particular tax situation. Investments involve the risk of loss, including total loss of principal.