If you’re a resident without access to an employer retirement plan, that doesn’t mean you’re out of luck. You can still open and add money to an individual retirement account (IRA) or Roth IRA.
- What is the rate of return for an IRA or Roth IRA?
The accounts are just containers that hold your cash and investments like mutual funds. The investment's performance determines your return.
- So, what’s the difference?
An IRA is pretax money; the contribution is deducted from your adjusted gross income when you file your tax return. When you spend the money after age 59 ½, income taxes are due based on your tax bracket at that time.
A Roth IRA is the reverse. Contributions are not deducted, in other words, contributions are after tax. When Roth IRA withdrawals occur after at least 5 years and age 59 ½, they are 100% tax-free. In addition, you can withdraw your contributions, but not the investment growth, at any age without any tax or penalty. That means the contributions to a Roth IRA could double as a backup emergency fund.
- I heard an IRA is better because it can reduce my student loan payment, is this true?
It’s partially true. If you are in an income-driven repayment plan, like Pay as You Earn (PAYE) or Revised Pay as You Earn (REPAYE), your payment is based on discretionary income which is derived from your adjusted gross income (AGI). Since IRA contributions reduce your AGI, it can also reduce your student loan payment. The most it can reduce your payment is 10% of your IRA contribution over 12 months.
Here’s an example. Someone that contributes the maximum $6,000 to an IRA for 2022 reduces their AGI and discretionary income by $6,000. 10% of the reduction in discretionary income is $600, which is the PAYE or REPAYE payment adjustment over a year. $600 divided by 12 monthly payments means your student loan payment is reduced by $50 per month for your $6,000 IRA contribution.
- Which is better the IRA or Roth IRA?
Most residents are in the lowest tax bracket they’ll experience in their career. So, it’s usually better to pay taxes now with the Roth IRA. Even those with student loans are better with the Roth IRA if their student loans will be paid off. Those anticipating loan forgiveness are generally the only group that might consider the IRA in residency.
- Should I open an account with my spouse?
Not possible. IRA stands for individual retirement account, so each spouse has their own account.
- Other key numbers:
The maximum contribution for 2022 is the lesser of your earned income (wages) or $6,000. This amount is raised to $7,000 for those age 50 or older. If one spouse does not have earned income, they can contribute based on the other spouse's income. The deadline for 2022 contributions is April 15, 2023.
Eligibility for a Roth IRA is phased out when modified AGI reaches $129,000-$144,000 single or $204,000-$214,000 married filing joint. In this case, use a Backdoor Roth IRA.
If your employer provides a retirement plan, deductibility for IRA contributions is phased out when modified AGI reaches $68,000-$78,000 single, $109,000-$129,000 married filing joint, or $204,000-$214,000 if only your spouse has an employer-provided plan in 2022.
Ready to start your own IRA or Roth IRA? Follow these steps.
- Payoff all credit card balances, auto loans, and personal loans.
- Build a cash reserve for upcoming expenses and emergencies.
- Determine your tolerance for investment risk.
- Learn the 7 ways to improve investment performance.
- Check the expenses at your chosen investment company and chosen investment funds.
- Company expenses are usually found in the firm's ADV. See WisMed Financial's ADV as of 1/13/2022.
- Investment fund expenses are available at Morningstar.com
- Open your IRA or Roth IRA at your chosen company or open an account through WisMed Financial and we'll make sure you are properly invested using low-cost funds.
- Track your contributions for tax return purposes. Since April 15th is the deadline for prior year contributions, investment companies do not send Form 5498, which shows your contributions, until May. You can file your tax return before Form 5498 arrives.
If you have questions, please contact us. 608-442-3750 email@example.com
This article has been updated from its original published version in the July 7, 2022 issue of Medigram.