Yahoo Finance 5 Common Myths About IRAs
To save for retirement, you don’t need an employer-sponsored plan such as a 401(k). You can also save for retirement on your own through an individual retirement account (IRA). Doing so can give you more flexibility in terms of what you invest in for retirement. However, IRAs have different rules than 401(k)s, such as around contribution limits and income limits to qualify for tax advantages.
Learn: The Average Retirement Age in 2023 in the US vs Canada
Read: What To Do If You Owe Back Taxes to the IRS
In addition to the potential confusion that can come from different Internal Revenue Service rules around IRAs, some people also don’t understand these accounts well because they tend to require a bit more proactiveness on the saver’s part.
Workplace retirement plans often guide employees toward saving and investing for retirement; some even auto-enroll employees and provide matching contributions to jumpstart retirement savings. IRAs, however, generally require more individual effort, although you could work with a professional such as a financial advisor or tax advisor for assistance.
Given this backdrop, some common IRA myths include:
Sponsored: Get Paid To Scroll. Start Now
1. IRAs Are Only for Self-Employed Individuals
Some people think that only self-employed people can or should use IRAs. If you’re covered by a retirement plan at work, then it could seem like there’s no reason to also invest within an IRA. However, IRAs can offer advantages like having more flexibility than 401(k)s, such as providing access to a broader range of investment choices, whereas your 401(k) can be more limited based on the funds your employer’s plan selects.
If you’re within income limits as defined by the IRS, you can be eligible for a tax deduction on contributions to an IRA, even if you or your spouse is covered by a workplace retirement plan. So, while many self-employed individuals do use IRAs, they’re not the only ones meant to have these accounts.
2. You Have to Choose Between an IRA and 401(k)
Related to the myth of IRAs only being for self-employed individuals is the myth that you can only choose one type of retirement account. Instead, you can use multiple retirement account types such as a 401(k) and IRA.
If you’re within IRS income limits, you can take tax deductions for contributions to both types of accounts, and even if you’re above the IRS income limits, you could still contribute to an IRA without taxing a tax deduction. Keep in mind, however, that rules for Roth IRA income limits differ. And you could face penalties for issues like contributing more than that tax year’s limit for either type of IRA account, as defined by the IRS.
However, the maximum contribution limits are separate for 401(k)s and IRAs.
“Those two limits are independent of each other. So you can max out your 401(k) and your IRA in the same year,” said Logan Allec, CPA and owner of Choice Tax Relief.
3. IRA Contributions Are Always Tax Deductible
While IRA contributions are often tax deductible, it’s important to realize that’s not always the case. As mentioned, if you or your spouse are covered by a retirement plan through your employer, then there are income limits that affect whether your traditional IRA contributions are also tax deductible.
“Some people still report that deduction on their tax return, but then the IRS is going to disallow it,” said Allec.
You could still contribute to an IRA, however, up to that year’s contribution limit, and enjoy tax-deferred growth, even if the initial contribution isn’t deductible, he added.
That would likely come into play if you’re above the income limits for a Roth IRA and you still want to save for retirement in an account that does not incur taxes on growth until withdrawals. Note, however, that making mistakes like going over the IRA contribution limit doesn’t just make those excess contributions not tax deductible but could also incur penalties.
4. Roth IRAs Are Always Better
Another common IRA myth or misconception is that Roth IRAs, if eligible, are always the better option. “It’s more case by case,” said Allec.
Roth IRAs help some people save on taxes in the long run, because the money can ultimately be withdrawn tax-free. However, you need to put after-tax dollars into Roth IRAs, and if you’re in a high tax bracket now but will be in a lower one in retirement, it could be to your advantage to use a traditional IRA.
“For most people, the choice should be based on their current tax rate versus their expected rate in retirement years. Higher rates later would favor the Roth IRA which also has no required minimum distributions in retirement,” said Brad Hartman, owner of Hartman Financial Planning.
Keep in mind that you don’t have to choose just one. You could have both a traditional IRA and a Roth IRA, though keep in mind that annual contribution limits apply on a combined basis across IRA accounts, rather than having separate limits for traditional and Roth IRAs.
“To help clear confusion about retirement accounts, I tell clients to think of them as a Tupperware container. Some containers defer taxes like a Traditional IRA or 401(k), others eliminate taxes later like a Roth IRA or 401(k) but almost all of them can hold the same type of investments. So pick the container you need based on your individual tax situation and then the investments to hold inside it,” explained Hartman.
5. You Just Have to Deposit Money Into the Account
Lastly, some people make the mistake of thinking that their work is done after opening an IRA and depositing money into the account. However, you need to make investment choices within the IRA to put that money to work.
This can be a problem in 401(k)s too, but in many cases, HR or someone else connected to your employer helps guide you through that process. “But with an IRA, you’re completely in control of that, and so it’s even more of a misconception that all you have to do is have money in the IRA,” said Allec.
If you don’t make investment decisions within your IRA, you could miss out on significant growth needed to afford retirement.
“I have had clients who put cash in every year up to the limit, but they’ve missed out on literally thousands of dollars of gains that the market has experienced because they didn’t actually make an investment, it was just sitting in cash,” said Allec.
Avoid IRA Mistakes
While these are common IRA myths and mistakes, you can find many reputable resources that help you avoid these types of issues. Looking at the IRS website, for example, explains things like income and contribution limits for IRAs fairly well, said Allec.
Read: 10 Things Boomers Should Consider Selling in Retirement
Because IRAs have a significant tax component to them, there’s a good chance that if you file taxes with an accountant, for example, they can help guide you on how to get the most out of these accounts from a tax perspective. A financial advisor can also help you set up an IRA in terms of choosing a saving and investment strategy that can put you on track for an enjoyable retirement.
More From GOBankingRates
How to Get $340/Year in Cash Back -- for Things You Already Buy
4 Reasons You Should Be Getting Your Paycheck Early, According to An Expert
10 Ways to Turn Your Six-Figure Salary Into Generational Wealth
This article originally appeared on GOBankingRates.com: 5 Common Myths About IRAs
