An employer’s retirement plan, such as a 401(k), 403(b) or 457 plan, can be a valuable wealth-building tool. These accounts afford workers a tax-advantaged way to save for their later years, with the potential added benefit of enjoying employer matching contributions. However, these plans are just one way to save for the future.

An individual retirement account (IRA) is a way to complement your employer’s savings plan, but many savers overlook it as a retirement planning option.  A 2017 survey from TIAA found that just 31% of Americans have an IRA and only 19% actively contribute to it. Needless to say, i you don't have an employer plan right now, you definitely need an IRA.

If you’re not clear how an IRA can help you build retirement security, here are the most important things you need to know.

Contribution Limits for Traditional and Roth IRAs

There are two basic types of IRA: traditional and Roth. Both are designed to achieve the same goal – saving for retirement while enjoying tax advantages – but they aren’t identical. (See Roth vs. Traditional IRA: Which Is Right for You?)

Just as it does for an employer’s plan, the Internal Revenue Service sets annual contribution limits for traditional and Roth IRAs. For 2018, that limit is $5,500 for either type of IRA. You’re allowed an additional $1,000 in catch-up contributions if you’re 50 or older. If you have more than one IRA, your total contributions for the year across those accounts can’t exceed the annual limit.

In terms of tax treatment, contributions to a traditional IRA are tax-deductible, but whether you can deduct the full amount of your contribution depends on your filing status, modified adjusted gross income and whether you’re covered by an employer’s plan at work. Let's say you’re single, have a MAGI of $73,000 or more, and are covered by a 401(k) or similar plan on the job: You wouldn’t be able to deduct any of your contributions to a traditional IRA for 2018.

There’s no deduction at all for contributions to a Roth IRA. Unlike traditional IRA contributions, Roth contributions are made with after-tax dollars. What you get in return: When you start making withdrawals at retirement, they are completely tax free. By contrast, traditional IRA withdrawals at retirement are taxed at your personal income tax rate.  

Who Can Make IRA Contributions?

Anyone can contribute to a traditional IRA if they’re under age 70½ and have earned income from a job, bonuses, etc. You could save in a traditional IRA and your workplace plan, if you have one. But again, whether you’d be able to deduct your IRA contributions would hinge on your filing status, income and employer’s retirement plan coverage.

The rules are different for Roth IRAs. Your income and filing status determine whether you can save in a Roth. For 2018, single filers can make a full contribution to a Roth if their MAGI is less than $120,000. Once they hit the $135,000 income threshold, they wouldn’t be able to include a Roth in their retirement plan. For married couples filing jointly, contributions phase out completely once income reaches $199,000 or higher. (See IRA Contributions: Eligibility and Deadlines.)

One other important point: If your spouse is currently not employed, you can set up an IRA in his or her name based on your earnings, which enables a family to double its IRA savings. Making Spousal IRA Contributions explains the details.

IRA Distribution Rules and Taxation

Another significant difference between traditional and Roth IRAs lies in how distributions from these accounts are treated for tax purposes. When you make qualified withdrawals from a traditional IRA in retirement, those withdrawals are taxed at your ordinary income tax rate. Qualified withdrawals from a Roth, on the other hand, are always tax-free.

If you’re eligible to contribute to a traditional or Roth IRA, you’d have to consider your tax outlook to determine which one offers the most benefit. If you’re making a higher income now but you expect to make less in retirement, getting the deduction for traditional IRA contributions in your higher earning years could mean paying less in taxes now, versus later. However, if you expect to have a higher income in retirement, being able to take money from a Roth IRA tax-free wouldn’t add to your tax liability.

With a traditional IRA, required minimum distributions kick in at age 70½. This is a minimum distribution you're required to take annually from your IRAs, based on your life expectancy. If you fail to take the distribution on time, you can face a hefty tax penalty. A Roth IRA has no distribution requirements during your lifetime. 

There’s one very important caveat to keep in mind with both accounts. Taking withdrawals before age 59½ can result in a 10% early withdrawal penalty unless your withdrawal falls under the umbrella of an exception allowed by the IRS. You can withdraw up to $10,000 penalty-free from an IRA, for instance, if you use it for the purchase of a first home. But if the money’s coming from a traditional IRA you’d still owe taxes on the earnings. You’d also owe taxes on any earnings distributions from a Roth if you make an early withdrawal before you’ve had the account for at least five years. (See 9 Penalty-Free IRA Withdrawals.)

The Bottom Line

Saving in a traditional or Roth IRA on top of what you’re socking away in your employer’s savings plan can help you build a bigger nest egg over time. It can also help to increase diversification in your portfolio if you have access to investment offerings in an IRA that you ordinarily wouldn’t have with an employer’s plan. Reviewing the tax rules for contributions and distributions for each type of IRA can help you decide which one is better for completing your retirement-planning picture.

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