What Is an IRA and Why Do I Care?

Retirement. For many of us, the word brings to mind images of old men with their pants pulled up to their chest eating dinner at four o’clock.

But times are changing. People are living and working longer and traditional retirement is a thing of the past. Today, people are spending their later years starting a second career, volunteering, traveling, or going back to school – to learn or to teach.

Getting older no longer means retirement in the traditional sense. It means the freedom and flexibility to live the life you’ve always wanted. That’s why today, more than ever, you need an IRA – what we at Aspiration think of as an “Individual Reinvention Account.”

Here’s what you need to know:

What Is an IRA?

Officially, IRA stands for “Individual Retirement Account.” There are different types, but they are all accounts designed to help you save assets for the long run. The government encourages you to save by offering deductions* on your taxes when you put money into your traditional IRA account.

Today, it’s more important than ever. While past generations could rely on pensions from their employers, more and more companies are either not offering these products or making their employees wait longer to become eligible for them.

That means that today it’s up to individuals to pay attention to their own savings. However, it also means we have more choice and flexibility on how we save.

Who Can Invest in a Traditional IRA?

A traditional IRA is pretty straightforward. Anyone (or their spouse) over the age of 18 and under the age of 70 ½ who receives taxable income can invest in one.

If you’re single and working, then you can invest in a traditional IRA. If you’re a married breadwinner, you can invest in a traditional IRA. If you’re a stay-at-home spouse and your spouse is earning taxable income, then you can invest in a traditional IRA. You can do it if you’re married and both working. All as long as you’re under the age of 70 ½.

You can invest in a traditional IRA whether or not you have an employer-sponsored retirement account. There’s no minimum to how long you have to be at one company. There’s no need to even be at just one company. You can change jobs, start a business, work as a freelancer, or all of the above. As long as you’re under 70 ½ and earning taxable income, you can invest in a traditional IRA. It’s that simple.

The government gives you a break off taxes you would otherwise pay in order to encourage you to put money into a traditional IRA.

What Are the Benefits of a Traditional IRA?

The greatest short-term benefit of a traditional IRA is the tax benefit. This benefit comes for you in two ways:

  1. You get immediate tax deductions when you invest in a traditional IRA
  2. You don’t have to pay taxes on your traditional IRA until you withdraw the money

That’s two different ways in which the government can give you a break off taxes you would otherwise pay in order to encourage you to put money into a traditional IRA.

Another benefit of an IRA is that you can set up automatic deductions from your bank account. That means you can put your savings on autopilot. No pain of making sure it gets budgeted in every month. No worries about accidentally overspending and thus not contributing. You can set it and forget it and watch your nest egg grow – all protected from having to pay taxes until you withdraw the money in retirement.

How Can a Traditional IRA Save You Money?

Taxes are necessary for society. They pay for roads, schools, and our military. But no one wants to pay more in taxes than they have to – especially when the government is purposely giving us a tax break in order to encourage us to save money in an IRA.

If you had $5,500 in your savings account right now, you’d have to pay taxes on any interest earned the following year. But if you put that same $5,500 in a traditional IRA, you would delay paying taxes on it and you could get a tax deduction for putting your money into the IRA. If you are in the 25 percent tax bracket and make a deductible IRA contribution of $5,500, you could deduct $1,375 off your tax bill if you otherwise qualify. In other words, a traditional IRA can help you lower your taxes.

IRA Contribution Limits

IRAs are beneficial, but there are limits to how much you can invest. These laws can change, but right now the limit is $5,500 annually if you’re under 50 and $6,500 annually if you’re over 50. However, if you’re married and you and your spouse both earn taxable income, then you can both set up an IRA, making your family contribution up to $11,000 if you’re under 50 and up to $13,000 if you’re over 50.

The amount you may deduct on your taxes from your IRA contributions can change based on whether or not you (or your spouse, if you’re married) have employer-sponsored retirement accounts and your adjusted gross income level.

What Happens If I Have to Sell Early?

In an ideal situation, you won’t need to access your IRA money until you hit the minimum age of 59 ½. However, if you find yourself in a bind, you can access your money with a 10% penalty for early withdrawal plus other federal and state taxes that are due.

However, there are some exceptions that let you remove money without penalty including purchasing a house, some types of higher education, and certain medical expenses if you become unemployed.

The main thing to remember is that the money is still there for you if you really need it, but you may pay a penalty for early withdrawal (prior to 59 ½) plus other taxes. But even the risk of a penalty can be better than keeping that money in a bank account or in investments that could cost you money in taxes every year.

If it is before the April tax deadline, it is also not too late to save money off your previous year’s taxes.

It’s Not Too Late

The sooner in life you begin saving for the future, the more chance you’ll have to let the power of compounding investment growth help you create the life you want in the future. But it is never too late to start saving.

And if it is before Tax Day, it is also not too late to save money off your previous year’s taxes. As long as you open the account before the tax deadline, then you’re still eligible for the deduction on your taxes.

Whether the future you imagine for yourself involves having the time to tutor a young person or to travel the world, an IRA – your Individual Reinvention Account – will help you reach that goal. And with Uncle Sam offering you dollar incentives to open an account, now is the time to start.

Hypothetical examples have been provided for illustrative purposes only and are not intended to represent performance of an Aspiration IRA. Contribution limits could be lower based on your income or other investments. Please visit our FAQs for more information on IRA contribution limits. This information should not be considered legal or tax advice. Please make sure you understand the tax consequences before making an investment.