Roth IRA/Traditional IRA
IRA's (Individual Retirement Arrangements) are a provision in the IRS tax code that allow individuals to save for retirement in tax-advantaged accounts and invest money either pre-tax or after tax. There are two IRAs that I will discuss specifically for the "normal" teacher: Roth and Traditional IRAs. Both have some similarities, but the main difference is when the money invested gets taxed.
Roth IRA
The Roth IRA is an after-tax investment account that grows tax-deferred and can be withdrawn after age 59 1/2 tax FREE. You can also withdraw contributions (not earnings) at any time tax/penalty free and also withdraw for death and disability before 59 1/2. The 2016 annual contribution limit is $5,500 ($11,000 total Married Filing Jointly) and there is an additional $1,000 catch-up provision for investors over age 50. The income phase-out for a Roth IRA starts at $184,000 and completely phases out at $194,000 (Married Filing Jointly). A Roth IRA does not save you anything on taxes now, but comes home tax-free in retirement.
Traditional IRA
The Traditional IRA is a pre-tax investment account that grows tax-deferred and can be withdrawn after age 59 1/2 at your ordinary income tax rate. The 2016 annual contribution limit is $5,500 ($11,000 total Married Filing Jointly) and there is an additional $1,000 catch-up provision for investors over age 50. Income limitations are greater for teachers in districts offering a 403(b)/401(k) plan - for 2016, the income phase out for a Trad. IRA to be fully deductible starts at $98,000 and stops at $118,000 Married Filing Jointly. Trad. IRAs create a tax deduction on page 1 of the IRS 1040 return (if qualified). Trad. IRA's also have Required Minimum Distributions (RMD's) starting at age 70.5 which means you must withdraw a certain percentage of your Trad. IRA each year after age 70.5. This number starts small, but gradually increases. You must factor this in when selecting between a Roth IRA and Traditional IRA - the government will receive taxes no matter what you pick!
You may also do what is called a "back-door" Roth IRA where you contribute to a non-deductible, traditional IRA and then convert it to a Roth. A non-deductible IRA has little to no advantages as it only saves you on the growth of your investments and you received no tax deductions on your contributions, but it may be necessary if your income exceeds the IRS limits.
Both Roth and Traditional IRAs are set up on your own through an investment firm like Vanguard, Fidelity or Schwab or online discount brokerage firm like E-Trade, TD Ameritrade or Scottrade. Do not use a bank for an IRA (low returns, high fees). Opening a Vanguard IRA and selecting Vanguard funds is virtually free if you waive the $20/year paper statements and elect to receive e-statements. IRAs can be set-up as an automatic monthly ACH withdraw from your checking account (cannot be done as a payroll deduction).
Choosing between a Roth IRA and Traditional IRA is a choice that takes careful planning and calculation (click for a calculator). The question is whether you wish to save on taxes now or later. A younger teacher will probably want to max out a Roth IRA before choosing a Traditional IRA or 403(b) because the income tax savings in retirement is much greater than the small amount of taxes saved now. Those wishing to save on taxes now or feel the government "match" with the tax deduction is worth paying income taxes in retirement will want to do a 403(b) or Traditional IRA. As a 35 year old teacher, I am going to max out Roth IRAs first before going to pre-tax investment accounts. Remember, teachers hired before 2012 have a pension that is taxable, so you may want to try and reduce your retirement income tax rate if possible.
Roth IRA
The Roth IRA is an after-tax investment account that grows tax-deferred and can be withdrawn after age 59 1/2 tax FREE. You can also withdraw contributions (not earnings) at any time tax/penalty free and also withdraw for death and disability before 59 1/2. The 2016 annual contribution limit is $5,500 ($11,000 total Married Filing Jointly) and there is an additional $1,000 catch-up provision for investors over age 50. The income phase-out for a Roth IRA starts at $184,000 and completely phases out at $194,000 (Married Filing Jointly). A Roth IRA does not save you anything on taxes now, but comes home tax-free in retirement.
Traditional IRA
The Traditional IRA is a pre-tax investment account that grows tax-deferred and can be withdrawn after age 59 1/2 at your ordinary income tax rate. The 2016 annual contribution limit is $5,500 ($11,000 total Married Filing Jointly) and there is an additional $1,000 catch-up provision for investors over age 50. Income limitations are greater for teachers in districts offering a 403(b)/401(k) plan - for 2016, the income phase out for a Trad. IRA to be fully deductible starts at $98,000 and stops at $118,000 Married Filing Jointly. Trad. IRAs create a tax deduction on page 1 of the IRS 1040 return (if qualified). Trad. IRA's also have Required Minimum Distributions (RMD's) starting at age 70.5 which means you must withdraw a certain percentage of your Trad. IRA each year after age 70.5. This number starts small, but gradually increases. You must factor this in when selecting between a Roth IRA and Traditional IRA - the government will receive taxes no matter what you pick!
You may also do what is called a "back-door" Roth IRA where you contribute to a non-deductible, traditional IRA and then convert it to a Roth. A non-deductible IRA has little to no advantages as it only saves you on the growth of your investments and you received no tax deductions on your contributions, but it may be necessary if your income exceeds the IRS limits.
Both Roth and Traditional IRAs are set up on your own through an investment firm like Vanguard, Fidelity or Schwab or online discount brokerage firm like E-Trade, TD Ameritrade or Scottrade. Do not use a bank for an IRA (low returns, high fees). Opening a Vanguard IRA and selecting Vanguard funds is virtually free if you waive the $20/year paper statements and elect to receive e-statements. IRAs can be set-up as an automatic monthly ACH withdraw from your checking account (cannot be done as a payroll deduction).
Choosing between a Roth IRA and Traditional IRA is a choice that takes careful planning and calculation (click for a calculator). The question is whether you wish to save on taxes now or later. A younger teacher will probably want to max out a Roth IRA before choosing a Traditional IRA or 403(b) because the income tax savings in retirement is much greater than the small amount of taxes saved now. Those wishing to save on taxes now or feel the government "match" with the tax deduction is worth paying income taxes in retirement will want to do a 403(b) or Traditional IRA. As a 35 year old teacher, I am going to max out Roth IRAs first before going to pre-tax investment accounts. Remember, teachers hired before 2012 have a pension that is taxable, so you may want to try and reduce your retirement income tax rate if possible.