Updated for tax year 2019. For tax year 2019 the contribution limit for Traditional IRA and Roth IRA accounts is $6,000. If you are over the age of 50 you can make an additional catch-up contribution of $1,000. The deadline to file 2019 taxes is Wednesday April 15, 2020.
Throughout the year, but most often during tax season, the subject of contributing to an Individual Retirement Account (IRA) comes up. IRAs are in the news, advertised on T.V., in print and of course on the Internet. Banks, credit unions and brokerage firms promoting the tax benefits of opening a Traditional IRA account with them.
In addition to the tax benefits, IRAs are also discussed in relation to retirement, a means of planning and saving for retirement. However, what often gets missed is the perspective that contributing to an IRA is actually a simple form of investing.
If you have always considered investing a rather confusing subject and not sure where to even being, opening a Traditional IRA account is a great way to start learning about investing and reduce your taxes.
What is an Individual Retirement Account?
An IRA is a special savings account. IRAs were introduced by the Employee Retirement Income Security Act of 1974 (ERISA) as a means of providing individuals with an option to save for retirement. As an incentive to save for retirement the IRS provides tax deductions. IRAs provide another retirement savings option for those who do not have access to an employer-sponsored 401(k) plan.
Money contributed to an IRA account can be allocated to other investments like mutual funds, bonds, stocks, and CDs. These investments then grow to earn you more money until you reach your retirement age. (More on investment options, below)
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My Recommended Online Tax Software: All three provide simple tax returns for free.
Here are the key points regarding IRAs’
- The two most common types of IRAs are a Traditional IRA and Roth IRA. For the purposes of receiving an immediate deduction for tax purposes, this article will be focusing on a Traditional IRA account.
- Traditional IRA accounts are available at most banks, credit unions and brokerage firms like Vanguard or E*TRADE.
- The maximum annual contribution for a Traditional IRA is $6,000. If you are over 50 you can contribute up to $7,000.
- Depending on where you establish an IRA account the minimum amount required to open an account could be as little as $100 or as much $1,000.
How Does Contributing to a Traditional IRA Lower Your Taxes?
Contributions to a Traditional IRA will lower your taxable income.
- If your taxable income is $40,000 and you don’t contribute to a Traditional IRA you will be taxed on the full $40,000.
- If you contribute $5,000 to a traditional IRA your taxable income would be reduced to $35,000.
Note: there are some stipulations that can impact how much of the IRA tax deduction you can take based on your other retirement plans, your spouse’s retirement plan and/or your income level. See the IRS guidelines here.
You can take advantage of the tax deduction in the year you contribute up to the time you file your taxes. For filing of 2019 taxes, you have until April 15th, 2020 to contribute. The tax deduction is not available if you file a tax extension.
Investment Options Once You Contribute to a Traditional IRA
In general, there are a couple of different ways you can open an IRA account and then allocate those funds to an investment vehicle. Your options for investing are generally based on the flexibility of the financial institution you’re working with.
Smaller Banks and Credit Unions
Smaller financial institutions that do not have access to a complete portfolio of investment securities will often provide Certificates of Deposit (CD’s) as an investment vehicle. Once you open up an IRA account you can choose the term of the CD you will be allocating your money to. The benefit of opening a Traditional IRA with these institutions is that the process and your options are simple. However, these investment solutions are limited. CD’s are viewed as a low rate of return investment vehicle. A low rate of return will impact how much money you will have when you retire. Minimums to open an IRA account and invest in CD’s could be as low as $100.
Large Banks and Brokerage Firms
Bank of America, Wells Fargo, E*TRADE, Vanguard, Fidelity are all full-service brokerage firms that provide a complete list of investment options once you open an IRA account. Mutual funds, stocks, bonds even annuities are available. The advantage of working with these firms is that the options they provide for investments will often provide a much greater return on your investment than a CD. In addition, they provide consulting services to help you choose the right investment based on your retirement timeline. Minimums for opening an IRA account are about $1,000. Additional contributions can be made in $100 increments.
Another option is a robo-advisor like Wealthsimple. They provide a number of different investment strategies when contributing to an IRA. In addition, they provide a financial adviser to help you with your investment decisions. Learn more about Wealthsimple IRA’s here.
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- Understanding Robo-Advisors and Automated Investing Video
- How to Open a Brokerage Account Online, In 4 Simple Steps
Get Started – Open a Traditional IRA Account
Estimates are that 35-40% of Americans have no retirement savings. For most, it’s not a matter of not wanting to save, rather the perspective that saving for retirement will take place sometime in the future. Unfortunately, this perspective circumvents the most important aspect of saving for retirement, which is the time value of money. The more time you have to invest, the more money you will have.
Regardless of your age opening a Traditional IRA account so you can plan for your retirement and take advantage of the tax deduction is a smart move. Traditional IRA accounts make saving for retirement easy. And in the process, you will learn a whole bunch more about investing.
- Contribute to an IRA with robo-advisor Wealthsimple – Socially Responsible Automated Investing $0 Account Minimum
- Simple Investing eBook – A Beginners Guide to Investments and How to Get Started.
- How-To Videos
- An Example of IRA Offerings – Ally Bank, Vanguard, T. Rowe Price.
Tax Software Resources: (My top three recommendations. I highly recommend these for doing your own taxes)
Do You Contribute to an IRA? Comment below.