What’s an IRA and do you really need one?

Do you enjoy camping or otherwise being out in the boonies? I do.

I don’t particularly enjoy being unprepared though. I think I might have mentioned a couple weeks ago that I embarked upon a short camping trip earlier this month. I think I also mentioned that camping actually turned into a day trip at the lake.

I wasn’t prepared.

I wasn’t unsafe or anything but just left a few key items back at home which would have proved beneficial to weathering some (okay, a lot of) rain.

This experience caused me to think about preparation (or lack thereof).

So, on this topic, let’s consider your long-term financial freedom.

How prepared are you and what tools do you really require to get the job done?

Recently, I’ve fielded a lot of questions about IRA’s. That is, young professionals often assume they need an IRA. I often receive the questions after the decision has been made.

Do you need an IRA?

First, I’d like to ensure you have a basic understanding about what an IRA actually is. From there, we’ll dig into some details.

An IRA is an Individual Retirement Arrangement (often referred to as an Individual Retirement Account). It quite simply is a type of account which you, as an individual, can set up in order to save for your future retirement.

As a side note, I’m typically a bit of a rebel when it comes to using financial words and jargon. That is, I don’t really like the word (or idea) of retirement or really other boring, overused financial terms either.

My reasoning is somewhat long-winded, so I’ll save that for another day. For now, suffice it to say that I just don’t think we should set an age restriction on achieving financial freedom.

Fair enough.

The IRA, like other retirement-savings vehicles, has a lot to do with taxes. In fact, it’s safe to say that it’s mostly all about taxes.

The tax laws allow you to set up an IRA, contribute money, choose particular investments for that money, and (hopefully) grow those investments over time — all without having to (immediately) deal with taxes on any earnings.

Rest assured, you will be taxed.

As Benjamin Franklin once said, “In this world nothing can be said to be certain, except death and taxes.”

Ain’t that the truth…

So, how does it work?

Here’s a really quick rundown of the traditional IRA:

1) You put money into the (traditional) IRA (currently a max of $5,500/year if under age 50)

2) You choose how that money is to be invested

3) Hopefully the investments grow over time (no guarantees)

4) Later (and preferably after age 59.5), you take the money out (withdraw) to live the life you want

5) For that particular year, you’ll receive a Form 1099-R showing the total amount of your withdrawals which you will need to treat as taxable income when you file your tax return.

6) Depending upon your total income, you may be able to take a deduction for the amount you contribute to the traditional IRA.

What about the Roth?

Steps one through four above are the same. However, Keep in mind that the annual limit ($5,500) applies to both traditional and Roth IRA’s.

The Roth provision allows you to contribute dollars which have already been taxed. This means at step five (above), your withdrawals will not be taxed. Of course, always subject to some hoops and hurdles.

Step six does not apply to the Roth. You may not take an income tax deduction for contributions to a Roth IRA.

Do you really need an IRA?

This is a good and really common question. My opinion is that most people think they need an IRA because it’s simply something that has been marketed quite well.

My guess is that you probably do not need an IRA.

If you are an employee of a company, organization, government or otherwise (i.e., you receive a Form W-2 at the end of the year), you likely have access to a retirement plan of some sort. These often have many different names (e.g., 401k, 403b, 457, TSP, and so on). I’ll refer to them all as employer-sponsored plans.

I’ve found that a lot of people are not fully maximizing the use of their employer-sponsored plans. Either they do not contribute at all, are confused about where to start, or feel the plan is somehow inferior to an IRA.

I find this most prevalent with U.S. federal government employees and military members. They have access to a rather fantastic, low-cost employer-sponsored plan called the Thrift Savings Plan (TSP). However, like I said, many do not contribute at all or insufficiently.

What’s worse?

A lot of so-called “advisers” will recommend and IRA instead of contributing to an otherwise fantastic employer plan. Why? Because they get to charge (and capture) a fee.

I once worked with a young military member who was doing quite well financially — considering his age and such. He had saved up some money and had zero debt. All is well, right?

Before we met, he was sold a Roth IRA that came with a hefty upfront commission fee, along with ongoing (and rather unnecessary) management fees.

This sort of stuff makes my blood boil.

A true fiduciary would not do this. A true adviser would have done a much better job.

A better solution would have been (briefly explained):

1) helping this individual capture the benefits of having a safe cash foundation (i.e., emergency fund) upon which to build a solid investment plan. I typically recommend having six months worth of expenses in a regular cash savings account.

2) Establishing a long-term investment plan which fully utilizes available tools. In this case, the primary tool was the government TSP. We’d like to get upward of 10–15% of income (consistently) going to long-term investing.

3) Keeping things simple by refraining from adding any unnecessary accounts and/or fees.

4) Providing education as to the benefits of ongoing financial planning and the abilities of a true financial adviser who acts in a fiduciary capacity at all times.

My guess is that you likely have a decent employer-sponsored plan available to you. I’d also venture to say that you likely have at least a question or two about how to effectively put it to work for you and your unique situation.

Sure, you might be offered an 800 number to talk to someone about it. Or, someone might come into your workplace ever so often to hand out a pamphlet or two.

That’s enough for some. However, since you’ve hung with me thus far through this article, I can say it’s likely not for you. You’re simply more engaged. You’re clearly interested in this topic and I’m sure you have a question or two that I can help you with.

If you’re a self-employed business owner/entrepreneur, there’s even more value I can provide to you.

So … do you need an IRA? I’d be happy to discuss all your personal details and help you answer that question.