If you were raised like me, then retirement was not a common topic of discussion. You retire when you die, literally. Many older people that I know are still working long hours to make ends meet; even high-income earners. Why is that? No retirement plans.
The average retirement savings by age 30-34 (my age group) is $21,731.92. This means, as of 2020 the average 30-34 year old has only $21,731.92 saved towards retirement. You may have already heard of IRA, 401(k) 403(b) through your workplace or your social circle, or maybe you have not.
What is an individual retirement account or IRA?
An IRA is a tax advantaged investing tool that individuals use to invest funds for retirement. There are several types of IRAs but I will discuss three:
- Traditional IRA – investments in this account grow tax-deferred. Contributions are before tax and withdrawals are taxed.
- Roth IRA – contributions are made after tax. Money invested grows tax-free and withdrawals in retirements are also tax-free
- Rollover IRA – created by transferring money from a 401(k) or 403(b) from a previous employer or other retirement account.
Traditional IRA
Contributions to traditional IRA accounts are tax-deductible, in most cases. So if you contribute $6,000 to your traditional IRA, your taxable income decreases by the amount of contribution. In 2021, the annual individual contribution to traditional IRA cannot exceed $6,000 ($7,000 if 50 or older).
- If you earn $40,000 this year and contribute $6,000 before taxes, then only $34,000 will be taxed.
- Anyone with an income can contribute to a traditional IRA, there are no income limits, unlike roth IRA
- When you reach the retirement age allowed to make withdrawals (59 1/2), the money you withdraw from this account is taxed federally at your ordinary income rate.
Roth IRA
In a roth IRA, money grows tax free and the withdrawal during retirement is also tax-free. You pay taxes on money contribute in the account and therefore, you cannot deduct contributions on your taxes. I personally love this option better than traditional IRA because when you are ready to start withdrawing your money, you will not have to pay federal tax.
- In 2021, you can contribute up to $6,000 ($7,000 if you are 50 or older).
- Not everyone can open up a roth IRA, you have to have a modified adjusted gross income below:
- $139,000 for a single filer
- $206,000 for married filing jointly
Rollover IRA
This is a transfer of funds from a retirement account into a traditional or roth IRA. Usually from a previous employer-sponsored retirement plan. It allows you to preserve the tax-deferred benefits of the retirement account without inferring any current taxes or early withdrawal penalties. Rollover IRA offers more flexibility than 401(k) or 403(b) in terms of investment options.
- I have a rollover IRA from a previous employer. I’m currently not making any contributions to this account. I invested 90% in stocks mutual funds and 10% in bonds.
Investing in retirement accounts is for long term. It is not advisable to withdraw from your IRA early although there are ways around it if it is something you have to do.
Whether you plan on retiring in the USA, Kenya, Nigeria, Caribbean islands or anywhere else in the world, it is important to plan for your retirement. You do not want your children to have to worry about financing the older you, and if you do not have children, you definitely do not want to depend on the government to take care of you!
Start early, start right now, start where you are. This is a marathon, not a sprint.