Guide To IRA Products And Their Recent Changes

Q: I’m ready to start saving for my retirement, but the choices are so confusing! I’m also Man sitting at laptop with phonewondering about the recent changes made to Individual Retirement Account (IRA) products through the SECURE and CARES acts. How do I choose the IRA that’s right for me, and what do I need to know?

A: It’s commendable that you’ve started thinking about your retirement planning. There are important distinctions between each type of IRA, so it’s best to review them before making your choice. There have also been several recent changes to the structure and limitations of IRAs with the passing of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in December 2019 and the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020.

This comprehensive guide to Individual Retirement Accounts, complete with updated information on the recent changes, can help you choose the option that best suits your needs.

Traditional IRA

Traditional IRAs are the most straightforward retirement accounts. Contributions are never taxed. Depending on eligibility, they may even be tax-deductible while significantly lowering your taxable income. Investment earnings aren’t taxed and there are no income limits for contributors.

The downside of traditional IRAs comes after contributions are made. All withdrawals made from a traditional IRA during retirement will be taxed at the going tax rate at that time.

Traditional IRAs are great for individuals who are currently in a higher tax bracket and anticipate being in a lower one during retirement. They’re also a good choice for employees who do not have access to a workplace-sponsored retirement plan.

Roth IRA

Roth IRAs are similar to their traditional counterparts, but have several notable differences. All contributions and growth are subject to taxes and are not tax-deductible; however, account holders can withdraw their money, tax-free, at retirement, as long as they are age 59 1/2 or older and have had the account for 5 years or longer.

There is also no age limit for contributions, though there are income and contribution limits for eligible contributors.  A Roth IRA is a good choice for individuals who anticipate being in a higher tax bracket during retirement and for those who may need to access some of their savings before retiring.

SEP IRA 

Simplified Employee Pension (SEP) IRAs are designed for individuals who have been employed in their place of work for at least three of the past five years. Contributions are made by the employer and are subject to a maximum amount. Earnings can grow tax-free and the account provides tax benefits for the employer. The annual contribution limits are higher than the limits for traditional IRAs, but are subject to fluctuation along with the business’s cash flow. Also, there are no catch-up contributions allowed for workers who are 50 years old and over.

A SEP IRA can be a good choice for small business owners wanting to avoid the heavy startup and maintenance costs that are commonly associated with conventional retirement plans.

Up until the passing of the SECURE Act, the limit for SEP IRAs was capped at 25% of an employee’s salary or up to $56,000, whichever is less. Now, that limit has been increased to $57,000.

SIMPLE IRA

A SIMPLE IRA, or a Savings Incentive Match Plan for Employees, functions similarly to a SEP IRA with the distinction that both employees and employers can make contributions. Eligibility requirements are forgiving, with employees who have earned at least $5,000 from the company opening the plan, and who expect to earn at least that amount in the current calendar year, being eligible to participate.

The contribution limit for SIMPLE IRAs was $13,000, with a catch-up limit of $3,000 until the passing of the SECURE Act, which increased the limit to $13,500. The legislation also established a new tax credit of up to $500 a year for businesses establishing a SIMPLE IRA with automatic enrollment. This credit is on top of the startup credit that is already available. Employers converting an existing plan to one with Eligible Automatic Contribution Arrangements (EACA) are also eligible for the $500 tax credit.

Spousal IRA

A Spousal IRA can be a traditional or Roth IRA and is designed for married couples where one spouse isn’t eligible for a traditional retirement account. Couples must file a joint tax return to be eligible and the account must be opened in the non-working spouse’s name. Contribution limits are determined by the working spouse’s income.

SECURE Act changes to retirement accounts

The SECURE Act made several significant changes for all IRAs:

RMD changes: IRAs have rules in place for required minimum distributions (RMDs), or a predetermined time when account holders must begin taking distributions. Up until Dec. 20, 2019, all holders of IRAs were no longer allowed to make contributions, and were required to begin taking distributions when they reached age 70 ½, irrespective of their employment status at the time. With the passing of the SECURE Act in December 2019, the age for RMDs increased to 72 years. Also as part of the SECURE Act, IRA holders can now continue making contributions indefinitely, as long as they can demonstrate earned income.

Changes for workplace retirement plans: Previously, employers were allowed to exclude employees who worked fewer than 1,000 hours per year from all retirement plans. With the passing of the SECURE Act, employees who work at least 500 hours in three consecutive years, and are at least age 21 at the end of the three-year period, are eligible to participate in employer retirement plans. This change takes effect in January 2021. Also, small businesses can now team up with other organizations when opening an employer retirement plan, enabling them to provide their employees with access to low-cost plans.

Changes for inherited IRAs: Until the passing of the SECURE Act, non-spousal inheritors of IRAs were allowed to withdraw funds from the account indefinitely. Now, they must empty the account within 10 years.

CARES Act changes to retirement accounts 

In March 2020, Congress passed the CARES Act in an effort to mitigate the economic fallout of the coronavirus pandemic. Part of the 300+ page legislation made changes to retirement accounts:

Changes for RMDs: The CARES Act waived all RMD requirements of IRAs for the year 2020.

Special allowances for coronavirus-related withdrawals: The CARES Act provides for expanded distribution options and favorable tax treatment for up to $100,000 of coronavirus-related distributions from eligible retirement plans to qualified individuals who have been adversely affected by COVID-19.

If you are considering opening an IRA, contact Destinations Credit Union.  We have many options for IRAs and give you the opportunity to build your nest egg slowly through regular contributions.

Consult your tax advisor for your individual situation.

Your Turn: Have you made any changes to your retirement accounts in light of the recently passed legislation? Tell us about it in the comments.

Sources:
https://www.irs.gov/newsroom/coronavirus-related-relief-for-retirement-plans-and-iras-questions-and-answers
https://www.usatoday.com/story/money/2020/04/05/changes-law-provide-retirement-relief-during-coronavirus-crisis/2950518001/
https://smartasset.com/retirement/simple-ira-vs-sep-ira
https://www.marketwatch.com/story/coronavirus-stimulus-package-tax-relief-withdraw-100k-from-your-ira-and-repay-in-3-years-with-zero-tax-liability-2020-03-27
https://news.cuna.org/articles/117793-brings-significant-changes-to-iras
https://www.investopedia.com/what-is-secure-act-how-affect-retirement-4692743
https://www.barrons.com/articles/here-are-4-things-retirement-savers-should-know-after-the-cares-act-and-secure-act-51589634001
https://www.investopedia.com/secure-act-4688468
https://weaver.com/blog/secure-act-brings-important-changes-retirement-plans

Is It Always Best to Pay Off Credit Cards Before Saving for Retirement?

By Janet Alvarez

image of credit card

Close-up of a credit card

Conventional wisdom says you should pay off your credit cards before saving for retirement. While it’s generally true you should pay off high-interest credit card debt as quickly as possible, there are a few situations where retirement savings should come first. Let’s look at the benefits of each approach.

Benefits of Paying Off Credit Cards First

Credit cards usually mean high-interest debt, and the longer you take to clear it, the more you’ll pay in interest. Here are some key reasons why you should pay off credit cards first:

  • High-interest credit card debt can be hard to make a dent in. If you’re not making more than the minimum payment on your credit card, compounding interest means your balance will barely budge. Even if you never use the card again, you will end up making payments for a long time.
  • If you’ve got credit card debt, your finances might be strained. High credit card debt is usually an indicator that you’re living above your means. You should get your spending and budget under control before investing in retirement.
  • High-interest debt rates are usually higher than market returns. If your credit cards carry a 25 percent interest rate, but a retirement fund is likely to only earn about 8 percent per year in the market, that’s a whopping difference of 17 percent that you’d be missing out on by saving for retirement instead of paying down credit cards.

Benefits of Saving for Retirement While Paying Off Cards

Still, saving for retirement is critical, and there are several reasons why you might wish to do so even if it takes you longer to pay down high-interest cards. Among these are:

  • 401(k)s and other retirement vehicles carry tax benefits. You can contribute to 401(k)s and certain other retirement plans using pre-tax dollars, thereby reducing your adjusted gross income and overall tax burden. This frees up extra cash for other purposes, such as credit card debt repayment.
  • The earlier you start saving for retirement, the better. Delaying retirement savings means missing out on months or years of compound interest. The longer you wait, the more likely you’ll end up pinching pennies in your 50s as you try to catch up on retirement savings. Compounding interest allows even people who never make big salaries to end up with comfortable nest eggs—but only if they start saving early.
  • Saving for retirement builds good financial habits. Socking money away for retirement is not only essential to your financial future, but it also helps you develop better money habits today. In doing so, you’ll learn how to budget better and address the sources of your debt. Plus, retirement accounts are usually difficult to raid (they often carry fees and penalties for early withdrawal). These extra hurdles discourage you from accessing this cash until you actually need it for retirement.

Special Situations May Help You Decide

Deciding whether to pay off credit cards or save for retirement first is a complex, personal issue. However, there are some special circumstances that suggest a clear direction:

  • Your employer offers a 401(k) match. A retirement savings match is free money. Even if you have high-interest credit cards, save at least the minimum required to get your full employer match, or you’re leaving money on the table.
  • Your credit cards have low interest rates. If you’re able to carry or transfer your credit card debt on low or zero percent APR cards, then it makes sense to save for retirement while paying these off, since your low interest rates mean debt won’t snowball quickly—assuming you’re not making new purchases that add to existing debt. (See: When to Do a Balance Transfer to Pay Off Credit Card Debt).
  • You’re age 50 or older. If you’re 50 or older, savings are critical because you’re that much closer to retirement, and have less time to save or allow money to compound. Plus, savers 50 or older are allowed extra catch-up contributions to their retirement plans.
  • You’re buying a house or applying for credit. If you’re applying for a mortgage or other forms of credit in the foreseeable future, you’ll want your credit card balances low, and your credit score as high as possible.

Paying off credit card debt and saving for retirement are both important financial goals. Often, they can even be achieved simultaneously. Regardless of which one you pick, commit today to setting aside extra cash each month to achieve your financial goal.

Janet Alvarez is the news anchor for WHYY/NPR and the Executive Editor of Wise Bread, an award-winning consumer education publication focused on helping consumers make smarter credit choices.