5 Myths About IRAs Debunked
More than half of Americans are missing out on one of the best retirement savings opportunities.
And the sad part is, it’s mostly because of a few persistent misconceptions.
We all know the importance of saving for retirement, and an individual retirement account is one of the best ways to do it. But how much do you really know about IRAs and how they work?
Do you know the difference between a traditional and Roth IRA, how self-directed IRAs work, and why some IRAs allow private investments while others don’t?
With so much information circulating online, it can leave many savers’ heads spinning. Or worse, some people just listen to whatever their ill informed friends or family tell them to be true.
The fact is, we’re not going to let these misconceptions persist any longer. Today we’re debunking five of the most common myths about IRAs so you can make an informed decision about your retirement savings plan.
Myth 1: The IRS Won’t Let You Save In A 401(k) And An IRA In The Same Year
It doesn’t matter if you contribute to an employer-sponsored retirement account – you can still save in a Traditional or Roth IRA.
If you’re under 50, you can put in up to $6,000 in 2021. If you’re 50 or older, you get a $1,000 catch-up that raises this limit to $7,000.
That said, if you are covered by your employer’s retirement plan, the IRS will restrict the deductibility of your contributions.
For 2021, if you are covered by a workplace plan, are single, and make less than $75,000, or if you’re married, file taxes jointly, and earn less than $125,000, you can contribute to a Traditional IRA and deduct either all or a portion of your contribution. These are the same income limits as last year.
However, if you are contributing to a Roth IRA , the limits have increased. For 2021, if you are single and make less than $140,000, or if you’re married, file taxes jointly, and earn less than $208,000, you can contribute to a Roth IRA and deduct either all or a portion of your contribution.
Depending on your situation, you might earn too much to contribute to a Roth IRA directly. Not to worry, there is a workaround called a “Backdoor Roth,” which involves making a nondeductible contribution to a Traditional IRA, then converting that to a Roth IRA.
If that sounds confusing, talk to a financial planner or tax adviser. Backdoor Roths are common practice, but they require some number crunching so you don’t overpay in taxes.
Myth 2: You Can’t Contribute To An IRA If You Don’t Have Your Own Income
Unlike other savings accounts, IRAs must have a single owner and can never be titled as a joint account. One of the main criteria for contributing to an IRA is having your own taxable income.
However, the IRS does make exceptions to this rule for non-working or low-income earning spouses. What you can do is piggyback off your spouse’s record of yearly income. This is called a spousal IRA.
It’s a great way to continue saving even if only one spouse has a job, which is especially important during times like we’re in now.
Myth 3: You Can Only Use Your IRA Money For Retirement
Because IRAs are designed as a retirement savings tool, you typically incur a 10% penalty if you pull money from your account before reaching age 59 ½.
It’s worth noting that this penalty only applies to IRAs where contributions are made with pre-tax dollars. For example, a Roth IRA, you can withdraw contributions for any reason at any time without being penalized.
That said, there are some situations where you can take money out of a traditional IRA early without getting slapped on the wrist.
First-time homebuyers can withdraw up to $10,000 from their IRA. And if you’re married and you and your spouse each have an IRA, you can each withdraw $10,000 for a combined total of $20,000.
Another situation where you can withdraw funds early penalty-free is to cover higher-education costs for yourself, a spouse, or a child.
A word of warning: be careful dipping into your IRA money too soon since you not only lose out on the principal amount withdrawn, but you’ll miss out on whatever growth that money could have achieved.
Myth 4: There Are No Private Investments In IRAs
A common-held belief is that IRAs can only invest in traditional, marketable securities. This simply is not true.
Stocks, bonds, and mutual funds are not mentioned in the Employee Retirement Income Security Act of 1974 or in the IRS code that rules them. But there are so many private investments your IRA can invest in, it’s easier for the IRS to list what can’t be held in your IRA instead.
Investments prohibited in IRAs include:
- Life insurance
Myth 5: You Don’t Make Enough To Contribute To An IRA
Whether you make $150 an hour or $13.50, the government allows you to contribute a certain amount of money each year into tax-sheltered accounts.
Anyone with earned income under the age of 70 ½ can contribute to a Traditional IRA, and anyone, regardless of age, with earned income can contribute to a Roth IRA.
Even if you can’t meet the maximum contribution limit, every dollar counts. You have until tax day of the following year to make your contribution for the current year.
So now that you know the truth about IRAs, don’t wait any longer.
The sooner you start maxing out your contribution limits, the sooner you’ll amass a sizable nest egg for retirement.
To a richer life,
The Rich Life Roadmap Team