Individual retirement arrangements are an easy way to save money for a retirement and to invest in a tax advantaged way. Owners of an IRA can invest in numerous ways through their retirement account and not have to pay taxes on any earnings until they take a distribution. In some IRA formats, the money actually grows completely tax free.
There are some definite advantages that come with opening and saving through an IRA, but there are some unique disadvantages that these accounts have in comparison to other retirement arrangements. Here is a look at some key pros and cons.
What Are the Pros of an IRA?
1. There is an IRA designed for everyone at every income level.
The two primary forms of an IRA are the traditional arrangement and the Roth arrangement. Anyone can open a traditional IRA. Roth IRAs are income restricted per individual or household. A new form of IRA, called the myRA, is guaranteed to never lose value because it’s backed by the US treasury and earns compounding interest. The myRA also has income restrictions in place.
2. The money is always accessible.
If you have a family emergency that requires some extra cash, the money from an IRA can be distributed at any time. There are certain financial penalties for taking an early distribution, so it should be avoided at all costs, but the money is there should it be needed and there is no other resource available.
3. A large portfolio of diverse investments can be accumulated.
As long as the investor does not personally gain from the investment being made, almost anything can become part of an IRA. This includes rental properties and even business equity. This allows for a high level of retirement security over time because even if an investment or two doesn’t perform as it should, the remainder of the portfolio and stabilize the remainder of the finances.
4. They can be monitored on a daily basis if desired.
Although most people aren’t going to become day traders through their IRA, it is possible to buy and sell daily through the tax advantage account if desired. Online access to IRA information through internet brokers allow for market trades to be initiated on a regular basis. There will be trading fees associated with these actions, of course, but making $1,000 of profit through buying and selling on $40 of fees is a pretty good return.
5. They are incredibly cheap to start.
There are often no fees associated with the creation of an IRA. With online brokers, many of them can be started with a simple application form for free. There’s not even a fee for transferring cash into the account. The only costs are annual maintenance costs and certain investment maintenance costs based on investment decisions.
6. Some IRA contributions can be claimed as a tax deduction.
This only applies to the traditional IRA contributions. Roth IRAs are created from post-tax dollars, which means the money comes out upon distribution tax-free. Traditional IRAs, on the other hand, are pre-tax dollars, which means income taxes are paid on distribution. Because most account holders will have a lower income level when taking distributions, however, their tax liabilities tend to be lower than if they paid the taxes today.
What Are the Cons of an IRA?
1. Contributions are capped.
For traditional and Roth IRAs, the maximum amount that someone can contribute to their IRA is $5,500. For a married couple, that means $11,000 can be saved in these tax advantaged accounts. For households who open up a myRA account instead, the cap is $15,000 – and then the funds rollover into a Roth IRA. There are penalties that can be assessed if more than the allowed contributions are placed into the retirement arrangement. Note: Baby boomers are able to contribute 10% more than others, but are still capped.
2. The money is locked in under fear of penalization.
There are age requirements in place on IRAs that required account holders to not access their money until at least the age of 59.5. Distributions can be made earlier than this, but there is a minimum 10% penalty on taking the distribution. On traditional IRAs, there would also be income tax payments that would need to be made at the end of the tax year, further reducing the amount received.
3. It cannot be used as collateral.
Unlike a 401k retirement arrangement [or similar structure for tax-exempt organizations], an IRA cannot be used as financial collateral whatsoever. With a 401k, loans can be secured against the balance of the retirement account and interest payments get paid directly to yourself. With the IRA, it is an independent account that only becomes part of your finances when you decide to take a distribution from it.
4. Certain investments come with some major fees.
There are two major issues with investments that occur within the context of an IRA. The first are dividend stocks, as only a certain amount of dividend payments are allowed within the retirement account before penalties apply on the amount received. The second is that certain investments called ETFs may reorganize under certain conditions, creating mandatory reorganization fees that can take a surprisingly hefty chunk of cash to make happen.
5. There are required minimum distributions that must be made.
For traditional IRAs, there is a required minimum distribution that must occur at the age of 70.5 and then annually thereafter. The time these withdrawals must occur changes from time to time as laws change, which can be another separate disadvantage on its own. Roth IRAs, however, have no minimum distributions that need to be made. It can be passed along to a person’s estate after they pass away if so desired. The only exception to this rule is if an individual has not officially retired.
6. Distributions cannot be rolled over into another account.
If you were willing to take the financial penalty and potential tax payments from an early distribution from an IRA, then it would be possible to rollover funds into another tax advantaged account. When the distributions are required because of age and are based on the uniform life expectancy table, it is not possible to rollover these funds into another tax advantaged account. These funds can still be saved and earn interest, just not tax-advantaged interest.
These IRA pros and cons show that there is the potential to save thousands of dollars in tax liabilities. Because the contribution levels are capped, however, it may not be the right investment vehicle for everyone. Evaluate these advantages and disadvantages today and you’ll know if this is the right way to make your money grow.