Individual Retirement Arrangements—better known as individual retirement accounts—can be a great way to save money for your retirement. They have specific tax benefits as well, depending on which IRA you choose. The most common types are Traditional IRAs and Roth IRAs. The Traditional IRA permits you to deduct a certain amount or all of your contributions from your taxes. More specifically, the money contributed to the Traditional IRA is tax-deferred. However, once you reach retirement age and begin withdrawing your contributions, you will incur a tax on each withdrawal. Plus, once you reach 701⁄2 years of age, you can no longer contribute to your IRA and must start making withdrawals.

Alternatively, if you should decide to open a Roth IRA, your contributions are not tax- deductible. In other words, you must pay tax on the money you contribute to a Roth IRA. This is a key benefit if you should decide to go that route. For example, a Roth IRA’s distribution is tax- free because its contributions have already been taxed. Also, a Roth IRA does not require a minimum distribution and you can continue to contribute after 70 1⁄2 years of age.

You don’t necessarily have to open an IRA to fund your retirement; you could contribute to your company’s 401K program, if they have one, for example. If you’re a small business owner, you also have an opportunity contribute to a simplified employee pension IRA (SEP IRA); more about this below. Before you decide which IRA is right for you, here you will find five essential things you should know about IRAs:

1. You Must Have Earned Income

Your earned income or taxable compensation can come from several sources. For example, salaries, wages, tips, bonuses, commissions and self-employment income are all suitable sources you can use to fund an IRA. As of 2019, you can contribute an amount equal to your taxable compensation up to $6,000 or $7,000 if you’re 50 years of age or older.

2. Income Requirements

The amount of money you can contribute to a Roth IRA is dependent upon how much your income is after modified adjusted gross income (MAGI). For 2019, single taxpayers cannot make Roth IRA contributions when their modified adjusted gross income exceeds $137,000. For married people who file jointly, the maximum income is $203,000. If your MAGI exceeds either the single taxpayers rate or the married filing jointly rate, there are tax strategies that will allow you to continue to contribute to an IRA.

3. Self-employed/Freelancer

If you are self-employed or have income from freelancing full-time or part-time, you can open a Simplified Employee Pension plan IRA (SEP IRA). An SEP IRA has a few tax benefits. For example, it offers self-employed or freelancers the opportunity to contribute much higher amounts than a Traditional or Roth IRA. The amount is determined by your income. For SEP IRAs, you can contribute up to 25% of any employee's eligible compensation up to a $55,000 limit for 2018 contributions and $56,000 for 2019. The deadline for setting up a SEP IRA for a year is as late as the due date (including extensions) of your business’s income tax return for that year.

4. "Catch-Up" Contributions

A catch-up contribution is a type of retirement savings contribution for people aged 50 or older. For Traditional or Roth IRA accounts, those individuals aged 50 or older can contribute an additional $1,000 for 2018. The catch-up provision of $1,000 is also available for 2019 for those aged 50 or older. This can be an incredible method to compensate for any missed contribution cycles so that you are able to fund your retirement account with as much as is permissible by law.

For example, if you turn 50 this year and put an extra $1,000 into your IRA for the next 20 years, and it earns an average return of 6% annually, you could increase your account to approximately $40,000 compared to someone who did not utilize this method.

Whether you’re thinking about a Traditional or Roth IRA, First State Bank has a variety of retirement options suited to your needs, and we are eager to help you plan your retirement every step of the way. We’ll even provide you with contribution limits, distributions, and investment options. Call us at your convenience at (940) 665-1711.