For most, one of life’s biggest goals is to have saved enough to live out their retirement peacefully and with financial independence. It is therefore, highly essential to have a proper retirement savings strategy in place.
Individual Retirement Accounts (IRA) can – and do – play a very vital role in such situations – being one of the most common ways for people to set aside money to be used during retirement. IRAs are of two types – traditional and Roth – money going into a traditional IRA is contributed as tax-deferred, but taxed when withdrawn, while money going into a Roth IRA only goes into the account after tax deductions but is tax-free when withdrawn. You can either contribute through one or the other, or sometimes even both, so long as you stay within the annual limit for making contributions.
Given the rather complex nature of IRAs, and the confusion around the same, there are several myths that surround them, which can often cause unnecessary distress on the part of both present and would-be contributors.
Here are three key misconceptions that surround IRAs, and what really is the truth about them:
Myth #1 – You cannot contribute to an IRA if you are unemployed:
Although it is mandatory to be an active income earner to qualify for contributing to an IRA, the Internal Revenue Service does have exceptional provisions whereby those who are technically unemployed can also make contributions. The most common of these is the spousal IRA.
As the name implies, the spousal IRA allows the unemployed spouse to contribute to the IRA (within contribution thresholds), so long as their spouse is employed. It works as a suitable option especially for women, who tend to take at least some time out of their careers at some point (either to have and/or raise children or to care for their elders). For them, the spousal IRA can allow them to track their retirement savings and keep to the norm – even if they are temporarily not working.
To qualify for spousal IRA, the non-working spouse must:
- Be married
- Be able to file returns for joint income tax
- Have a household earned income that matches the contributions made by the working spouse to their IRA, and the non-working spouse to their spousal IRA
Myth #2 – If your earnings are more than the specified income thresholds, you will be disqualified:
Whereas earning a large income is always a great thing, it can disappoint when it comes to contributing to an IRA. This is because there are set limits when it comes to making IRA contributions.
In the event that you don’t have a workplace retirement plan in place already, it is possible for you to make contributions (and later fully deduct your contributions) even if you make a salary as high as $1 million. Limits can still arise, however, in case you are not covered but your husband or wife is.
In the event that you do have a workplace retirement plan, your income will cast a larger shadow on your eligibility to contribute. If you earn $72,000 or more and are single, or earn $119,000 or more, and are married, you are ineligible to deduct any part of your traditional IRA contributions. That said, you could continue to contribute to a traditional, non-deductible IRA.
Roth IRAs, however, are much more stringent. Earning a higher income can easily disqualify you from making direct contributions. This applies even if your current workplace does not offer you a retirement plan.
All said and done, you could still save via the “backdoor” option – this happens when you make a non-deductible contribution to a traditional IRA, and thereafter and then convert said contributions into a Roth IRA one.
Myth #3 – You cannot contribute to an IRA if you have a workplace plan in place:
This is a big confusion surrounding IRAs – and a false one too. Many think that if their workplace has a retirement plan like a 401(k) in place, they are ineligible to contribute to IRAs. The truth, however, is that if you are employed and under the age of 70 years and 6 months, you can contribute to a traditional IRA. The only caveat here would be that you would not be able to make deductible contributions. For Roth IRAs, you can contribute at any age, so long as your income lies below a certain limit.