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Saving for retirement helps ensure that your golden years are indeed golden. One of the best ways to stash cash for retirement is opening and funding an individual retirement account. Commonly known as an IRA, this savings vehicle offers you a relatively safe place to invest your nest egg.

What Is An IRA?

An IRA is a retirement account into which you deposit stocks, bonds, mutual funds and other assets. These assets are then allowed to grow on a tax deferred or tax free basis. Ideally, the investments in your IRA will grow in value over time accruing a substantial amount of money for your retirement years. You can open an IRA in addition to other types of retirement accounts, such as employer-sponsored 401(k)s.

Several types of IRA accounts exist, including traditional IRAs, Roth IRAs, SEP IRAs and SIMPLE IRAs. Traditional and Roth IRAs are personal retirement accounts that offer different tax advantages. The money deposited into a traditional IRA is not taxed at the time of deposit, but is taxed when you remove the money. Roth IRA deposits are taxed when you make the deposit, but you pay no taxes when you withdraw the money. SEP IRAs are for self-employed individuals and SIMPLE IRAs are designed for small employers to offer their employees.

How IRAs Work

You are eligible to open and contribute to a personal IRA if you or your spouse (if you filed jointly) received taxable income during the year, and you were not age 70 ½ by the end of the year. Allowable income for contribution purposes includes wages and salaries, commissions, self-employment income, alimony and nontaxable combat pay.

A variety of financial institutions offer IRAs, including banks, savings and loans institutions, credit unions, brokerage firms and mutual fund companies. When you open an IRA, you deposit a specified amount of money and choose from various investments. Most IRA providers offer a variety of investment opportunities, including stocks and bonds, mutual funds, money market funds and CDs. This allows you to take advantage of a diversified mix of investments, which is a safe practice with your retirement money.

Deposits and Withdrawals

You can currently deposit up to $5,000 per year if you are 50 and under and $6,000 per year from 50 until the age of 70 ½. There are income limits that determine how much you can contribute to a Roth IRA, but none exist for a traditional IRA. Single filers who make in excess of $125,000 per year and joint filers earning more than $183,000 per year may not contribute to a Roth IRA in 2012.

You can withdraw money from your traditional IRA at any time, but you will have to pay a 10 percent penalty on the money you withdraw if you are younger than 59 ½. You will also have pay income tax on the money you withdraw. After 59 ½, you can withdraw funds without paying a penalty, but you will still have to pay income tax on the amount withdrawn. You must start withdrawing minimum distributions from an IRA each year when you turn 70 ½.

You can withdraw money from a Roth IRA before the age of 59 ½ without penalty providing that you only withdraw from the deposits that you put into the account, not any earnings.  There are no minimum distribution requirements for Roth IRAs.

A few exceptions exist to the 10 percent penalty rule. You can withdraw money from an IRA without being penalized in order to pay for college expenses, medical expenses greater than 7.5 percent of your adjusted gross income, up to $10,000 for a first-time home purchase and costs arising because of a sudden disability. You can also avoid penalties if you withdraw the money to roll over into another type of retirement account, such as from a traditional IRA to a Roth IRA.

The Benefits Of An IRA

An IRA’s biggest benefit is that your investments in the account grow on a tax deferred or tax free basis. This allows your money to grow faster than if you had to pay taxes on it each year.

Additionally, the 10 percent penalty for early withdrawals also reduces your incentive to pull money out of your account. This helps to ensure that you will have sufficient funds on which to live when you retire.

It’s Not Free To Open And Maintain An IRA

Banks and other financial institutions have varying fee structures for IRAs so it’s a good idea to shop around. Some companies charge an annual account maintenance fee of $25 to $30, while others do not. There are also commission fees, which can range from as little as $7 to over $40.

Tax Planning

You can open an IRA at any time of the year, but the money must be filed by the tax filing due date. If you deposit money into an IRA after the due date, it will be considered a contribution for the following year’s taxes.

Now that you understand the benefits and basics of opening an IRA, you can make informed choices that are likely to help you enjoy full, vibrant retirement years.

Sources

• IRS
• IRS
• CNN

A certificate of deposit (CD) is a low-risk savings product that requires investing a fixed amount of money for a predetermined time period. In return for locking your money into the account for a set term — from a few months to several years — the bank pays you a higher interest rate than you would earn from a standard savings account. Interest is added to the account on a periodic basis throughout the CD’s term.

What Is A CD?

When you purchase a CD, you invest a fixed amount of money for a specified period of time. The most common duration is between three months and five years. Generally, the longer the CD’s term, the higher the interest rate you receive on your money. While you can withdraw the money before the set term finishes, you pay a substantial early withdrawal penalty if you do so. When the CD matures, you receive the original amount you deposited plus accrued interest. At maturity, you can cash the CD in, let it automatically renew into the same length of term or roll it over into another term.

There are generally no fees to open a CD account. Minimum deposit requirements do exist and vary between financial institutions. Five-hundred dollars is often the lowest minimum you’ll find. Accounts requiring higher minimums often pay better interest rates.

Types of CDs

Fixed Rate: Often referred to as a traditional CD, this account offers you an interest rate that stays constant throughout the term.

Variable Rate: Interest rates vary with this type of account, rising and falling according to variable rate indices.

Bump Up: If interest rates rise during the term of your CD, you can inform the bank that you want to “bump up” to the higher interest rate for the remainder of the term. Generally, the bump-up feature is only allowed once a term and bump up CDs usually start at a lower interest rate than fixed rate CDs.

Liquid: With this account, you can withdraw part of your deposit without paying a penalty. The trade-off for being able to pull out money is that the interest rate is usually lower than a traditional CD.

Investment Benefits

CDs are one of the safest investments you can make. At the end of the term with a fixed rate CD, you get back what you deposited plus a guaranteed amount of interest. Your investment is also protected if the bank where your CD is held fails because CDs are insured by the FDIC for up to $250,000 per account.

Fixed rate CDs also offer you a stable interest rate for a specified period of time. If interest rates fall during the term of your fixed rate CD, you continue to enjoy the higher interest rate locked in when you opened the account.

Investment Risks

Any financial investment involves some risk. With fixed rate CDs, there are potential opportunity costs. You risk the interest rates rising above the fixed rate and losing out on the earnings you could have received if you had invested your money elsewhere. Variable rate CDs also pose a risk, as you have no control over the prevailing interest rate.

Investment Strategy

Determining the length of time to open a CD depends on how long you want your money tied up and whether the interest rates are likely to go up or down. Fixed rate short-term CDs are often best when rates are on the rise, as they can be renewed at a higher rate. When interest rates look like they will be falling, it’s best to purchase a long-term fixed rate CD, as an account with a locked-in rate will earn a higher return over the long run.

Timing is especially important for success with bump-up CDs. Since these accounts start at a lower interest rate than standard CDs, it’s important that interest rates rise and make a bump-up possible.

Take advantage of timing by laddering, which involves staggering CD investments so that you open accounts with varied maturity dates and term lengths. For instance, instead of opening one 5-year CD for $20,000, which ties up all of your money for a long period, invest in four CDs of $5,000 with terms of 6 months, 1 year, 3 years and 5 years. This guarantees you steady access to your cash and enables you to take advantage of interest fluctuations. When one of your CDs matures, you can cash it in or reinvest it to keep the ladder going.

Additional Considerations

Knowing a CD’s APR and APY helps you understand the potential for financial return. APR refers to the annual percentage rate paid on the CD. APY refers to the annual percentage yield, which indicates what is earned during the CD term as the money compounds. For example, a three-year CD with an initial investment of $1,000 and a 5 percent APR will yield $50 the first year, and then the second year the new account total of $1,050 will earn a compound interest of $52.50, and so forth.

Cautions

Beware of CD interest rates substantially higher than other lending institutions. Such accounts may not be backed by a legitimate lender or be federally insured. Also consider avoiding CDs with call features, which refer to the bank’s right to terminate the CD after a set period of time if interest rates fall.

CDs offer a safe way to invest money over a specified period of time and receive more interest than you would in a regular savings account. Take a look at the wide variety of options available in CDs, and you’re sure to find an account that fits your financial needs.

Sources

• Federal Deposit Insurance Corporation
• Federal Deposit Insurance Corporation
• U.S. Securities and Exchange Commission
• CNN
• The Wall Street Journal
• The Wall Street Journal

Individual retirement accounts (IRAs) provide a relatively safe way to grow your money for retirement and they offer significant tax advantages.

There are two types of personal retirement accounts you can open: Roth and traditional IRAs. Understanding each account and their differences helps you determine which IRA is best for your financial situation and retirement plans.

Traditional IRA Basics

A traditional IRA is a personal retirement savings account held at a bank or a brokerage firm that can be funded with investments such as stocks, bonds and mutual funds offered through the financial institution where your account is held. Traditional IRAs provide tax savings, including tax-free growth of earned interest, dividends and capital gains while the money is in the account. You also usually claim a tax deduction each year that you make a contribution to a traditional IRA. While your contributions to a traditional IRA are not taxed, you pay have to pay taxes when you remove the funds from the account at retirement.

Roth IRA Basics

A Roth IRA is a personal retirement savings account also held at a bank or brokerage firm that can be funded with a wide variety of investments, including stocks, bonds and mutual funds. Roth IRAs also offer tax savings, including tax-free growth of earned interest, dividends and capital gains while the money is in the account. Contributions made to a Roth IRA are taxed before they reach the account, but you are not taxed when you withdraw the money. Withdrawals of contributions are tax free after the Roth IRA has been open five years, and you can withdraw investment earnings tax free after you reach the age of 59 ½.

Traditional Vs. Roth IRAs

When it comes to investments, traditional and Roth IRAs work the same way. You fund the IRA and then move the money into various investments. With both types of accounts, the interest, dividends and capital gains grow tax free. If you are employed and earning an income, you can currently contribute to both types of accounts up to $5,000 per year until the age of 49 and $6,000 per year if you are 50 or older. Contributions to either type of IRA must come from taxable income earned from working. However, there are several important differences between traditional and Roth IRAs.

Consider the following differences when making a decision regarding which type of IRA is right for your financial situation.

Tax Deferral

Traditional: Contributions are taxed at the prevailing tax rate when money is taken from the account at retirement. Your contributions are not taxed when you initially deposit them into your account.

Roth: Because your contributions are taxed before they land in your account, you money is not taxed when it is removed from the account.

Age Limits

Traditional: No contributions are allowed once you reach age 70 ½.

Roth: No age limits exist on contributions.

Income Caps

Traditional: Anyone with a taxable income can contribute to a traditional IRA, no matter how much they earn.

Roth: There are income limits for contributing. In 2011, single individuals with a modified adjusted gross income of $125,000 and higher could not contribute to a Roth IRA.

Tax Deductibility

Traditional: Contributions may be tax deductible. Eligibility is dependent on a variety of factors including whether you are currently participating in an employer-sponsored retirement plan such as a 401(k), SEP IRA or SIMPLE IRA. Enrollment in one of these pans can limit or preclude tax deductibility.

Income also dictates if and how much a person can deduct. In 2011, for instance, an individual filing single or as head of household with no active participation in an employer-sponsored retirement plan who earned $56,000 or less in modified adjusted gross income could fully deduct all contributions to a traditional IRA. Individuals earning from $56,000 to $66,000 got a partial deduction, and those earning more than $66,000 had no deduction.

Roth: No contributions are tax deductible.

Required Minimum Distribution (RMD)

Traditional: Account owners must begin receiving minimum distributions of money in the account on April 1 of the year following their turning 70 ½-years-old.

Roth: No RMD.

Early Disbursement

Traditional: If you pull money out of the account before the age of 59 ½, you will be subject to an early distribution penalty. Exceptions to the early disbursement penalty rule include withdrawing money in order to pay for college expenses, medical costs greater than 7.5% of your adjusted gross income and expenses due to sudden disability. You can also withdraw up to $10,000 penalty free for a first-time home purchase. Finally, there are no penalties if you transfer the money into another type of retirement account.

Roth: After the account has been open five years, you can withdraw any money you deposited into the account without incurring a penalty. You will, however, usually pay a penalty if you withdraw investment earnings before the age of 59 ½.

Deciding Which Account Is Best for You

If you do not meet the income requirements for a Roth IRA, a traditional IRA is your only choice. Otherwise, you need to take a few factors into consideration when making your decision.

If you want to take advantage of the tax deductibility of your IRA contributions, you might consider choosing a traditional IRA. Opting for a traditional IRA also makes sense if you expect to be in a lower tax bracket when you retire, because you will pay less taxes at that time than you would now.

However, the flexible benefits of a Roth IRA may make it a more appealing choice. You might benefit from your ability to withdraw contributions without penalties. You might also prefer to have no minimum distribution requirements.  Finally, if you expect to be in a higher tax bracket when you retire, choosing a Roth will allow you to get your contributions taxed at a lower rate now, and you won’t have to worry about taxes later.

Splitting Your Contributions

If you are eligible for a Roth and traditional IRA, you may find it advantageous to split your maximum contribution between the two by depositing the tax deductible amount of your income into your traditional IRA and the remainder into a Roth. When considering doing this, factor in potential additional costs such as fees associated with funding both accounts. Your total contributions to both IRAs can’t be more than your limit for the year.

Now that you’re armed with the facts when it comes to Roth and traditional IRAs, you can use them to your advantage when planning for your retirement years.

Sources

IRS

IRS

IRS

IRS

CNN

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