An IRA or Individual Retirement Account is one method to save for financial security at retirement. There are several steps to starting an IRA that will allow the investor to maximize their investment over time. It is important to first assess the current financial situation of the investor, then choose a type of IRA and finally to begin investing.
Investing small amounts in an IRA early will allow the investment to grow significantly over time. It is important to budget for this expense, but other priorities may need to be paid first. Items such as rent, food and clothing of course are basic necessities but paying of debt is also important. Gather all financial information together and determine how much money is left after paying all basic necessities, but before paying debts. Determine how much of the remaining amount could be put into an IRA on a monthly basis without significantly impacting paying off the remaining debts. An amount as small as $100 a month to start with will grow over time and as debts are paid off the amount can be increased.
There are different types of IRA’s available to investors. Contributions to a traditional IRA generally are not taxed until they are paid out at retirement. This means the contributions made to the account may be tax deductible and reduce your taxable income. Contributions to a Roth IRA are not tax deductible, however if all qualifications are met the payments are tax free. A Roth IRA also allows individuals to continue to contribute after the age of 70 ½ where traditional IRA’s do not. A Roth IRA must be set up as a Roth when it is originated. A traditional IRA cannot be changed to a ROTH.
It is important to begin investing as early as possible. Investing small amounts over time will result in significant growth from compound interest. An example is if an investor puts $100 a month into an IRA at the age of 20 and invests the same amount until they retire at 70 the account will be worth approximately. $241,832, assuming a 5% interest rate. The same investment will yield only $40,270 over 20 years. This makes it extremely important to invest early. If possible set up the account so that the money is removed automatically and deposited into the IRA. This will help ensure a steady increase in the investment.
An IRA can be started with a bank or other financial institution. Review the details of the account with a financial professional for additional advice on how much to deposit and how often. Investing early in an IRA will also provide an account to roll other retirement investments into should it be necessary. 401(k) accounts must be rolled into an eligible retirement account when the employee leaves the business. An existing IRA can make this process easier.
An IRA is only one part of planning for financial security during retirement. Other sources of income such as pensions, 401(k) and social security should be included in any financial planning.