The concept of saving for retirement is not addressed as early as it should be, in fact with all the alarming data, it is something that should be on the forefront of everyone’s thoughts. While most employers offer 401(k) plans to their employees, you should also be making contributions to a self driven retirement plan early in your career, especially when you’re earning less money.

What Is An IRA?

An Individual Retirement Account (IRA) is, as the name suggests, a savings tool for retirement which offers tax breaks. The 2020 maximum annual IRA contribution limit is $6,000 (or $7,000 if you are 50 years of age or older). You are able to deduct your IRA contributions on your personal tax returns up to the maximum IRA contribution for the given year.

Is There A Catch?

Unfortunately, yes.

You are only able to fully benefit from these deductions if your modified adjusted gross income is $65,000 or less ($104,000 or less if married filing jointly). Your modified-adjusted gross income is calculated by taking your adjusted gross income from your 1040 (U.S. Individual Income Tax Return) and adding back deductions from student loan interest/tuition, half of your self-employment tax, passive income or loss, rental losses, excluded foreign income, rental losses, interest from EE savings bonds used to pay higher education expenses, Employer paid adoption expenses, and losses from a publicly traded partnership.

It is important to note several of these add backs are probably not applicable to someone just entering the workforce and will likely be much more simple.

When your modified-adjusted gross income exceeds $75,000 for single tax filers ($124,000 for married couples), the IRS does not allow any deductions.

Partial deductions are available for income that falls between the ($65,000-75,000) range, so we definitely recommend speaking with a licensed tax or financial consultant before making any investment decisions.

Not So Fast…

IRA brokerage accounts are able to grow tax-deferred until retirement withdrawals occur at age 59.5 or later – yes, the IRS really does track it to half-a-year.

If your annual gross income exceeds $75,000 (married income exceeds $125,000) or you don’t care about tax deductibles granted in IRA’s and merely want to avoid taxes on retirement fund contributions, then a Roth IRA Account is for you.

Roth IRAs are funded with after-tax dollars. Therefore, contributions are not tax deductible, however, once you are able to withdraw funds at age 59.5, they are tax-free

Just like an IRA, the Roth IRA has a 2020 annual maximum contribution limits of $6,000 (or $7,000 if you are 50 years of age or older). Once singles make over $139,000 and married couples make over $206,000 they are no longer able to contribute to their Roth IRA or begin making contributions.

A Traditional IRA/Roth IRA Is Simply An Investment Vehicle

It’s worth noting that a traditional IRA and a Roth IRA are merely types of investment accounts. There are a host of investment options you can choose to hold within your IRA/Roth IRA, including stocks, bonds, mutual funds, and other investment options available at the investment firm/brokerage firm at which you decide to open your IRA/Roth IRA. The returns you see in your IRA/Roth IRA will vary depending on what type of investment you decide to hold in the account.

They Won’t Make You Rich

IRAs and Roth IRAs themselves won’t make you rich. However, you can save several thousands of dollars on income tax by contributing to an IRA before you make over $75,000. Additionally, you can avoid taxes altogether via contributions to a Roth IRA before earning over $139,000.

On the other hand, contributing to these accounts earlier in your career allow you to reap the benefits of compound interest which could better position you for retirement.

For example, assume that you are 25 and at the beginning of this year you began contributing $500 a month ($6,000 annually) to an IRA, which you decide to invest in stocks and stock mutual funds, and did this for the next 35 years at which point you will be 60 years old. If we anticipate 8% annual returns or interest (based on the what the stock market has returned on average since its inception in 1926). By the time you are able to withdraw those funds at age 60 your account would be worth $1,640,197.43.

One key thing to keep in mind is that you can have multiple IRA/Roth IRA accounts at multiple investment/brokerage firms, you can even have both a traditional IRA and Roth IRA and make contributions at the same time (as long as you qualify). However, keep in mind that the $6,000 annual maximum IRA/Roth IRA limit is tracked by the IRS based on your social security number, meaning the sum of the contributions to all your IRA and Roth IRA accounts combined cannot be more than $6,000.

It is also important note while you may not be able to take tax deductions after exceeding $75,000 in annual income, you can still make contributions to your IRA because there is no income cap for making contributions to a traditional IRA.

Additionally, you can contribute to your Roth IRA as long as you make less than $139,000 (or $206,000 for married couples) and be able to withdraw the entire $1,640,197.43 without any capital gains tax obligations!