Investing 101: How Does an IRA Work?

IRAs, or individual retirement accounts, have been used for many years as a means to reduce taxable income and save money for retirement. Monies placed into a traditional IRA are not subject to income taxes and continue to earn interest, which is also not taxed.

The skinny on contributions

Each year, the Internal Revenue Service, sets limits as to how much an individual can contribute to an IRA plan. The limit is currently $5,000 for individuals under the age of 50, and $6,500 for those over 50 years of age. So each year, you can contribute to your traditional IRA and those monies, along with the interest earnings, are not taxed until they are withdrawn.

How to plan for required minimum distributions

You can keep your money sheltered until you hit retirement age, but once you reach 70.5 years of age, federal tax law requires that you begin receiving distributions from your IRA. Thereby, they require that you take what they call “required minimum distributions,” or RMDs. This is when the federal government gets to receive some of those taxes that they have waited so long to collect.

Your RMD is calculated using your age and the balance in your traditional IRA at the end of the prior calendar year. This means that no RMD is the same. The RMD amount is different for each IRA and for each person.

For example, let’s say in 2018 you are reaching the age of 70.5 and you are required to take an RMD for 2018. You also have the option to wait and take it in 2019, as long as you do so by April 1, 2019. One option may be more beneficial than the other, based upon your individual tax circumstances. (Note that if you choose to postpone your 2018 RMD and take it in 2019, you will need to take both distributions in the same year.)