What is an IRA and how does it work?
Individual Retirement Accounts (IRA) are savings accounts designed to house retirement funds and provide options to earn investment gains. Unlike a 401(k), IRAs do not require an employer-sponsored plan so you may open and add funds to an account as long as you have taxable income and stay within the yearly contribution limits. If eligible, you could invest in both an IRA and 401(k) to take advantage of more savings opportunities and the flexibility that comes with each account type.
Let’s explore how you can contribute to and withdraw funds from an IRA and the tax advantages that come with a traditional account versus a Roth IRA.
Contribution limits
In 2023, total contributions to all your traditional and Roth IRAs cannot exceed $6,500, or $7,500 if you’re 50 or older. This additional $1,000, called a “catch-up contribution,” allows older individuals to make up for previous years if they didn’t save enough.
The 2023 yearly limit is a $500 increase from 2022. Roth IRA contribution limits also may be affected by your tax filing status and gross income.
Withdrawal timeline
Withdrawals from a traditional IRA are taxable. You can withdraw at any time, but you will incur a 10% penalty fee if you do so under age 59 ½.
On the other hand, Roth distributions typically are not taxable. However, the same penalty fee applies to distributions made before age 59 ½.
There are some exceptions to the penalty tax. Find the list of qualified early IRA distributions on the IRS website.
Tax benefits
Traditional IRAs allow you to make contributions that may be fully or partially tax-deductible, which lowers your taxable income. These funds are taxed later when you take a distribution from the account.
Roth IRA contributions are not deductible from your taxable income. However, because you pay taxes at the time of contribution, your withdrawals may be tax free.
We recommend consulting with a tax advisor for information specific to your financial situation.
Once you’ve selected an account type, funding your IRA is simple. You can write a check, transfer from another bank account, or initiate a transfer or rollover from another retirement account (these funds will not be taxed as a distribution if moved directly to the new IRA). Next, think about setting up an automatic transfer to your IRA on a schedule that works for your budget so you continue growing your balance to feel confident heading toward retirement.
Interested in IRAs? Learn about our account options online or visit a First Federal banking center today!
