Many Americans have no retirement savings at all. Families across the U.S. have a median of just $5,000 stashed away, according to an Economic Policy Institute of 2013 Survey of Consumer Finance data. But families who have a retirement account have managed to tuck away a median of $60,000 for the future. That’s certainly better than nothing, but no where close to enough money to pay for several decades of retirement.
While the obvious solution is boosting contributions to work-sponsored retirement plans, another type of account can also help. Individual retirement accounts, also known as IRAs, offer a smart solution for those looking to grow wealth for retirement and score helpful tax benefits along the way. Individuals can invest up to $5,500 per year across both types of IRAs — traditional and Roth. If you’re age 50 and older, you can contribute $6,500 in 2017.
Depending on the situation, having an IRA could mean the difference between enjoying retirement and struggling to get by. Here are a few ways an IRA could save you from a serious retirement shortfall:
[Read: 5 New 401(k) and IRA Rules for 2017 .]
More money to cover emergencies. Never having to go to work again might sound like a dream come true, but it won’t save you from all of life’s struggles. While you may never have to clock in again, you’ll still have home repairs to deal with, cars that break down and medical bills to pay.
Investing in an IRA on top of your work-sponsored retirement plan means you’ll have more money at your disposal that you can use to cover unexpected repairs, car failures and medical emergencies. “Fixed income sources may be becoming a smaller portion of any retiree’s income, so beefing up other retirement savings is important,” says Minnesota financial advisor Jamie Pomeroy. “Start investing in an IRA early, be consistent with it, don’t waiver, and you might just find your IRA showing up at just the right time, helping to save your finances in retirement should other fixed income sources be less than expected.”
Enjoy tax-free money in the future. With a traditional IRA, most people make tax-deductible contributions now and then pay taxes on their distributions later. With a Roth IRA, the exact opposite is true. When you invest in a Roth IRA, your contributions are made with after-tax dollars and your distributions are tax-free down the line.
Having several accounts with different tax treatments is a great way to diversify your retirement assets. If you’re contributing to a traditional 401(k) plan at work, investing in a Roth IRA outside of your job can be beneficial if your income allows it. You’re essentially hedging your bets about your future tax rate. “You’ll have a bucket of money that is pre-tax, and a bucket that is post-tax,” Pomeroy says. “That way, once you’re retired, you’ll have the option of withdrawing from one or the other depending upon your individual tax situation.”
[See: 10 Steps to Max Out Your IRA.]
Invest your dollars where it makes the most sense. While investing enough in your employer-sponsored 401(k) plan to get company matching contributions is generally a good idea, some financial advisors say you should look closely at your plan before you max it out. Large expense ratios and management fees can eat away at your returns and cost you big money over the years. And if your employer only offers a few funds, there’s not much you can do.
With an IRA, you decide which firm and investments get your money. You can shop around for the best places to open an IRA based on ongoing costs, your choice of investments or any other criteria you choose. “Prudently invested, IRA accounts often avoid layers of administration fees levied to company plans,” says Indiana financial advisor Tom Diem of Diem Wealth Management. The money you’re not paying in administration fees will help grow your account faster, which means more money in your pocket when you retire.
Use your IRA as a dream fund. A lifetime of work should be rewarded, yet few people save enough to follow their dreams once they retire. By opening a traditional or Roth IRA now and contributing the max each year, you can set money aside to travel and enjoy life. “An IRA can help cover any type of expense in retirement,” Pomeroy says. “If you’ve done some financial planning, and this makes sense for you, why not think of your IRA as the account that you’ll withdraw from to take your annual vacation?”
Since you can begin taking distributions from your traditional IRA without paying a penalty at age 59 ½ and you can withdraw your contributions to a Roth IRA at any time, they typically provide more flexibility than 401(k) plans. Not only could having a dream fund “save” your retirement, but it could make it a lot more fun, too.
[See: How to Save for Retirement on Less Than $40,000 Per Year.]
Roth IRAs provide additional flexibility. You can withdraw your contributions to a Roth IRA without penalty. However, if you withdraw any of the investment earnings before age 59 ½ you might trigger income tax and the early withdrawal penalty. Roth IRAs also allow you to access cash quickly and often without any tax consequences in retirement. Having access to tax-free money can make your retirement a lot less bumpy and more enjoyable.
If you’re worried you’re behind when it comes to saving for retirement, take the initiative to open an IRA. Provided you meet the income requirements, these accounts can help fill the gap between what you’re saving now and how much you need for retirement.
“An investment in an IRA or Roth IRA can grow to be a substantial sum over the years, and is an important asset to provide income in retirement,” says financial advisor David Niggel of Key Wealth Partners in Lancaster, Pennsylvania. “Along with your company sponsored retirement plan, your IRA, Social Security and proper planning, you should be able to sustain a comfortable lifestyle in retirement.”
Jeff Rose is a certified financial planner, U.S. combat veteran and the founder of GoodFinancialCents.com.
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5 Ways an IRA Can Save Your Retirement originally appeared on usnews.com
