One Day You’ll Be Old. Don’t Be Old And Broke: Breaking Down IRA’s

Last week I finally opened an IRA. Retirement funds always seemed very confusing (because they are), so I just avoided them assuming I could work out another way to be able to purchase my pimped out gold wheelchair in retirement. Most people are able to opt in for a 401k at their jobs, many with employer contributions (hello free money!), but since modeling is freelance work, I had to take care of my retirement plan myself. I really wish I had done this sooner, and since I’m sure there are plenty more people like me out there who find this shit daunting, I’ve done my research and broken it down a little.

The deadline for opening/contributing for an IRA for 2011 is April 15th, so if you haven’t filed, you still have time.

Traditional IRA

Allow your contributions to grow tax-free, AND have the ability to lower your tax bill. For example, let’s say you made $30,000 during the year, and you put $2,000 of it into an IRA , you would pay income tax on only $28,000.

Eligibility: No income cap for those not covered by an employer-sponsored retirement plan. If you do have a 401k, you must have a gross income of less than $66k.

Contribute: As much as you’re able to. Max is $5k – max it out if you can.

Withdraw: Withdrawals are taxed as income, and you must start withdrawing by the time you’re 70.5. You cannot access the money until you’re 59.5 unless you want to pay a 10% penalty and pay income tax on the amount. Penalty-free withdrawals are permitted for first time home purchases up to $10k, for higher education expenses, for payment of your health insurance premiums after 12 weeks of unemployment, for medical expenses that exceed 7.5% of your gross income, or if you die (in which case you won’t care anyway).

Roth IRA

Financial experts seem to prefer this option, because although you cannot deduct your contribution from your taxes (so in the above example, you would still pay taxes on the full $30k of income), the money can be withdrawn tax-free in retirement, likely resulting in higher gains.

Eligibility: If your single gross income is less than $107k, and $169 for married couples.

Contribute: Max of $5k annually

Withdraw: Tax-free and penalty-free withdraws after the account has been opened for 5 years if you are 59.5 or need the money for the same qualified expenses listed above. Penalty free but not tax free early withdraws are permitted for higher education expenses.

Last year I incorporated myself for tax purposes, and therefore opened a SEP-IRA which is best for those who are self employed or small business owners. The maximum contribution allowed is $49k. For more info on this kind of retirement plan check out  http://www.sepira.com — I didn’t want to bore you with more numbers. yawn.

Mint.com also has a great IRA-choosing tool: Mint IRA center

Ok I figured out the best IRA for me. Now what?

Many banks offer IRA’s – I personally used Merill Lynch because they have partnered with Bank of America (my bank) so I can easily access my account online, plus they have a good reputation. It’s really important to search for a company that suits your needs. Other companies offering no-fee IRA’s include Fidelity Investments and Vanguard.

Questions to ask your potential financial planner:

– Is there a minimum initial investment? Minimum contributions?

-What sorts of fees are assessed to the account?

-Does the company offer automatic contributions?

-What investment options are available? Can you invest in stocks? Mutual funds? Real estate?

Some banks are limited to only offering IRA CD’s at fixed rates of about 1.5%. Ally Bank has a high yield CD available now for 1.75%. This may be the safest option, but especially for younger investors, this is not the advised route. An investor with a longer investment period should take higher risks with their IRA’s. This could mean investing in more mutual funds (risky) and stocks (riskier) like I did, since these provide greater rewards over the long term.  They say the formula for figuring it out is 100-age = the percent you should have invested in stocks. As I get closer to retirement, I can change the diversification to include more weight in safer funds. If you’re like me, you don’t know how to invest in stocks and funds and all that good stuff — so just leave it in the hands of your financial advisor to pick the right investments for you (He may even like doing it because those people are sick like that).

So that’s my breakdown on IRA’s. I obviously am not a financial expert, BUT I do know that this is one investment that everyone needs to make…because one day you’ll be old, and there’s nothing worse than being old than being old and broke. Consider it like a guaranteed happy ending. Everyone likes those.