Looking Over the Overlooked IRA

Less than 20 percent of Americans contribute to an IRA, missing tax and retirement savings benefits

by Daniel M. Keady, CFP

Mr. Keady is Senior Director of Financial Planning at TIAA-CREF . Visit tiaa-creff.org

Whether it is paying your child’s college tuition, taking an annual vacation or replacing a faulty kitchen appliance, financial obligations seem to be rapidly expanding for many American families.

Everyone knows they should save up for retirement, but many struggle with how much to put away and what strategies to implement for their particular financial situation. Planning and even thinking about retirement can be daunting. But what would happen in the midst of retirement if you run out of money? According to the new, fourth annual TIAA-CREF 2015 IRA Survey, 58 percent of Americans would go back to work, 13 percent would seek government assistance and 10 percent would plan to sell assets and belongings.

A proactive step individuals can take to strengthen their financial security is early contributions to an Individual Retirement Account (IRA) – a plan that can help maximize retirement savings and offer benefits today and in retirement.

An under-utilized asset

Only 18 percent of respondents are currently contributing to one, suggesting that IRAs are significantly underutilized. A partial explanation for why many Americans do not contribute or even consider using an IRA is a lack of solid understanding on what they entail and the benefits they can offer for long-term retirement planning.

According to the survey:

  • Forty-three percent of survey respondents were unable to identify the correct description of an IRA.
  • Forty-two percent of survey respondents are not currently contributing to an IRA and would not consider one as part of their retirement strategy. 
  • Of this group, 39 percent said they don’t know enough about IRAs to consider one – up from 29 percent in TIAA-CREF’s 2014 IRA survey

The level of IRA education appears to be impacted by a couple of factors including age, level of education and income. Not surprisingly, individuals between the ages of 18 to 34 are least likely to contribute to an IRA and only 46 percent of this particular respondent group could correctly define an IRA.

At 28 percent, college graduates are far more likely to contribute to an IRA versus 18 percent overall. Sixteen percent of those with some college education contribute to an IRA, while only 12 percent of those with a high school education or less contribute. In a similar vein, 81 percent of Americans with an income of $100k or more demonstrate an understanding of an IRA, compared to the 42 percent with an income of $35k.

The Three C’s of Saving

To help clarify this disconnect for all varying income and education levels, as well as ages, the “three C’s” speak to how to maximize retirement savings through an IRA.

1. Contribute to an IRA
As mentioned above, IRAs can help save for future retirement and provide contributors with tax advantages today. With a Traditional IRA, you will not pay taxes on your earnings until you tap into those funds in retirement. Furthermore, many taxpayers can receive an up-front income tax deduction on contributions to a Traditional IRA. While the money you save in a Roth IRA is not tax deductible, you can withdraw both your contributions and earnings tax-free in retirement. In addition to the 18 percent of Americans contributing to an IRA, another 14 percent of respondents in the TIAA-CREF IRA survey this year said they have an IRA but they are not actively putting money into it. It is important to note that an individual can make contributions that count for the previous tax year through April 15. You can save as much as $5,500 each year into a Traditional or Roth IRA and if you are 50 or older, you can contribute up to $6,500.

individuals between the ages of 18 to 34 are least likely to contribute to an IRA and only 46 percent of this particular respondent group could correctly define an IRA

2. Combine your IRA with your 403(b) or 401(k) plan
If you lack access to an employer-based savings plan, an IRA can be an effective way to save for retirement. Out of the respondents who do not currently contribute to an IRA, 53 percent do not have an employer-sponsored plan such as a 403(b) or 401(k), which is up from the 38 percent reported in 2014. For those that do participate in 403(b) or 401(k) plans, advisors and plan sponsors have the opportunity to provide sound advice on how to utilize both.

Using both an IRA and workplace retirement plan may allow you to save more for retirement and gain tax diversification. It is worth considering saving enough in your workplace retirement plan to get any matching funds offered by your employer before saving money in an IRA. Even better, contributing the maximum to both your employer-sponsored retirement plan and an IRA can help accelerate your retirement savings.

For an example, looking at the 2015 tax year, you could potentially save a combined total of $23,500 to both an IRA and workplace retirement plan, or as much as $30,500 to both accounts if you are older than 50. According to the survey, it appears that out of those who do have both an employer-sponsored plan and an IRA, more are making good decisions about how to use them: 31 percent of those surveyed are getting their maximum employer match before contributing to an IRA, up from 27 percent last year, while 18 percent are maxing out contributions to their employer plan before contributing to an IRA, up from nine percent last year.

3. Consolidate your retirement accounts
Having assets in multiple accounts from different providers can be difficult to manage and keep track of – 30 percent of respondents said they still have assets in one or more retirement plans at a former employer, up from 22 percent in 2014 and 15 percent in 2013.

By consolidating or “rolling over” your retirement plans into an IRA, you can streamline investment planning and gain a clearer picture of how prepared you are for retirement. In addition to simplifying your investment planning and minimizing the hassle of managing multiple investments, an IRA rollover can also increase the number of investment options you can access. Also, when you use both a workplace retirement plan and an IRA, you can also enjoy tax benefits in retirement.

The money you take out of your Roth IRA in retirement is tax-free, unlike most funds from a workplace retirement plan, investing in a Roth can actually decrease your tax bill in retirement. If you are concerned about facing higher tax rates in retirement, saving through a Roth IRA can mitigate those risks. Thirty percent of respondents expected an IRA rollover to be less time-consuming than other tasks including renewing a driver’s license, getting a dental cleaning or closing on a home.

That said, it is important to note that consolidating accounts in an IRA is not your only choice for workplace retirement accounts. Other options worth considering are leaving it where it is, rolling it into a new employer’s plan, if permitted, or withdrawing cash. Each particular option has its pros and cons in terms of investment options, services, fees and expenses, withdrawals, required minimum distributions, other plan features and tax treatment.

Planning for retirement does not need to be onerous and whatever one’s financial goals are, there are readily available solutions that can help you achieve greater financial well-being in the present and in the future. To learn more about how an IRA can complement your overall retirement plan, reach out to a financial advisor today.