Decision Points: When Should I Open an IRA Account?
Retirement may seem like a long way off, but early preparation can save you from future stress. A popular tool for retirement is an individual retirement account (IRA), which allows you to save money for retirement with tax benefits and interest. While investing early is always a good idea, some people may want to wait before plunking their money down on retirement. Here is a guide to help you figure out the best time to open an IRA account:
Types of IRAs
There are several different kinds of IRA accounts available. Traditional IRAs allow you to contribute income before it is taxed. Your money will not be taxed until you withdraw from your account during retirement.
Roth IRA contributions are made after tax, which is generally better for individuals in lower tax brackets and younger people whose tax rate will probably rise over time.
SEP-IRA and SIMPLE IRA programs are established by employers or self-employed people. A SIMPLE IRA, for example, can only be established by employers who had no more than 100 employees earning at least $5,000 in compensation during the preceding calendar year.
Immediate Investment Advantages
Generally speaking, thanks to compound interest, the sooner you start saving in an IRA, the better, because your interest accumulates over the years. Jean-Luc Bourdon, financial literacy advocate and regular contributor to “CPA Insider,” explained that saving as soon as possible means benefiting from tax benefits earlier.
“Ideally, as soon as you earn your first paycheck, you’d save some of it in an IRA to benefit from tax and investment-compounding benefits,” he says.
Interest-compounding benefits mean that if you invest now, you will make more in the upcoming years as interest builds on your interest. If you are heavily taxed, traditional IRAs allow you to take the money that normally goes toward your taxes, and keep those funds within your portfolio instead.
If you are making a down payment on a mortgage, you can even withdraw a large chunk of your contributions and earnings without paying a fee. However, it is ideal to not withdraw funds to maintain compounded interest. For many people, investing early makes the most financial sense, but investing for the future will only work if you are secure right now.
Immediate Investment Disadvantages
Funds that go toward an IRA may serve you better elsewhere. According to Bourdon, if you have an employment retirement plan with employer-matching contributions, you should maximize your investments in this plan before setting your sights on an IRA.
Keep in mind that an IRA will tie up your cash for a long time, and early withdrawal from a traditional IRA will result in tax penalties. Note, however, that you can withdraw your contributions (but not your earnings) without penalty from a Roth IRA. You can withdraw contributions from your account because they haven’t been deducted from your tax returns.
Delayed investment Advantages
While you should set your sights on long-term investment, your present needs may require you to wait before you open an IRA. Before you invest, you may want to pay off any pressing loans–particularly credit card debt. Consumer debt racks up a great amount of interest, and its negative impact on your credit score can affect your interest rates for loans in the future.
Additionally, you still do not want your IRA to push you into debt. Before you allocate money for your IRA, make sure you have enough funds to cover essential expenses such as food, rent, gas and medical supplies. You should generally build up an emergency fund for three to six months worth of living expenses. You may be able to start your emergency savings while investing in your IRA, if you plan wisely and budget carefully.
Delayed Investment Disadvantages
Waiting to invest in an IRA means missing out on tax benefits and the magic of compound interest. You may need some time before you are ready to open an IRA, but you should always keep the future in mind. While preparing to invest can take a lot of work, starting as soon as possible will pay off in the long run.