7 Facts Every Therapist Needs to Know about IRAs
The IRS calls them Individual Retirement Arrangements. Pretty much everyone else calls them Individual Retirement Accounts.
Regardless of what you think the acronym stands for, IRAs are confusing things. But they’re important, too. For many therapists they form the cornerstone of retirement planning.
As a business owner, you have many more sophisticated (and confusing!) retirement plan options available to you, but often they aren’t worth the hassle!
With that in mind, I wanted to share with you five things every therapist needs to know about IRAs. They’ll help you decide if using an ordinary IRA is the right way for you to save for retirement.
1. An IRA is often the easiest way to save for retirement.
An ordinary IRA is often the perfect way to save for retirement because it’s so easy. Anyone who has earnings from a job can open and contribute to an IRA. It doesn’t need to be “sponsored” by your business (your practice) which means there is virtually no paperwork.
Despite having the lowest annual contribution limit of the many different retirement plans available to you as a business owner, you can still save quite a bit! For 2023, you can contribute up to $6,500 to an ordinary IRA. If you’re 50 or over, you can contribute an additional $1,000 for a total allowed annual contribution of $7,500. Note that these limits are for the year 2023 and typically increase each year (to adjust for inflation).
If you plan to save less than those limits this year, there’s little need for dealing with more complicated retirement plan options. Just open that IRA and start saving!
2. An ‘ordinary’ IRA is different from a SEP-IRA… is different from a SIMPLE IRA.
Speaking of those more complicated retirement plan options available to you as a business owner, two of them are the SEP-IRA and SIMPLE IRA. Despite having the word IRA in their names, they function quite differently than the ‘ordinary’ IRAs we’re discussing in this article.
SEP-IRAs and SIMPLE IRAs are retirement plans sponsored and controlled by a business. That’s unlike an ordinary IRA which is opened and controlled by an individual (that’s you!)
SEP-IRAs and SIMPLE IRAs just happen to use the IRA as the accounts each employee owns. The rules governing SEP-IRAs and SIMPLE IRAs are much different (and more complex) than the rules we’re talking about here.
I know… this stuff is confusing! The important point to remember is that if you already have a SEP-IRA or SIMPLE IRA, the rules we discuss don’t apply to you.
3. A Roth IRA is often a better choice than a Traditional IRA (but either is a win!)
Back in the land of ‘ordinary’ IRAs, you do still have two choices. You can open and contribute to either a Traditional IRA or a Roth IRA. (Technically, you can contribute to both types, as long as your total contributions across both accounts don’t exceed those annual contribution limits we discussed above.)
Which is better for you? Well, I can’t say for certain since I don’t know you or your life, but in many cases the Roth IRA is a better choice.
The reasons I prefer the Roth IRA over a Traditional IRA for most (but not all) therapists are complex and involve a lot of nerdy finance math (which I LOVE, by the way). I won’t bore you with all those details today, but especially if you’re under 45 years old, I’d lean toward the Roth.
But don’t get stuck in this decision! Funding either a Roth IRA or a Traditional IRA is a huge win! And of course, if you suspect you need individualized advice to make this Roth versus Traditional decision, please do seek out a qualified and licensed professional!
4. An IRA is a container — NOT an investment!
One of the most important things to remember about IRAs is that they are NOT an investment. IRAs are simply a type of account, just like a bank account.
In other words, an IRA is a container for your investments, but not the investment itself.
In fact, IRAs can ‘contain’ virtually any type of investment you want. There are certain restrictions, but you don’t have to really worry about them. Why? Because a prudent investment strategy uses highly diversified, passively managed and low-cost investment funds. And those are just fine to have in your IRA.
When you open your IRA, you’ll need to pick an investment fund. If you're not certain what fund is right, I often recommend Vanguard Target Date Retirement Funds. Using these funds is as simple as retirement investment gets, and while this won’t be the perfect fund for everyone, it often is a very good choice. You simply pick the fund with the year closest to your expected retirement year and the fund takes care of the rest. Other firms besides Vanguard offer these target date funds, but I’ve found many of them have outrageous expense ratios. Which brings us to…
5. Watch for hidden fees & expenses!
The investing world can be a scary place. The thing I find most scary is all the hidden fees and expenses. These might not seem like a big deal, but if you’re investing for several decades they really add up — and take a big bite out of money that is rightfully yours.
No matter what financial institution or professional you’re working with, be sure to ask and understand the various fees, expenses and other charges you’ll be paying. The conversation might be a little bit awkward, but it’s your money and you have the right (enshrined in federal and state law) to get honest answers!
I mentioned Vanguard Target Date Funds just above, and you can open an IRA with Vanguard directly. While Vanguard isn’t perfect, I think they’re among the best in the business, and offer some of the lowest cost (often THE lowest cost) investing and retirement plan options out there.
6. You can contribute to an IRA up until tax time!
One of the cool things about saving into an IRA is that you have time flexibility. As we discussed above, the amount you can contribute to your IRA is limited each year. But you generally have up until the personal tax filing deadline to fund that amount. So for example, if you’re under 50 this year you can contribute up to $6,500 for calendar year 2023. But you have until the tax deadline in April 2024 to make that decision. So if you find yourself wishing you had contributed to an IRA after you’ve rung in the new year, not to worry! The IRA is still an option available to you! (As long as you follow the income limitation rules… which brings us to…)
7. IRA income limitations are important - know before you contribute!
Okay, so this bit is the most confusing piece. But don’t stress, we’ll get through it together.
Both Roth IRAs and Traditional IRAs come with restrictions on how you can use them — but mostly only once your income hits certain amounts.
Oh, and the income restrictions for Roth IRAs are different from Traditional IRAs. Because of course they are.
Roth IRA Income Restrictions
The Roth IRA rules are reasonably straightforward. Once your income hits a certain threshold, your ability to fund the Roth IRA begins to phase out. That means while you may still contribute to a Roth IRA, you’re only allowed to contribute a somewhat lower amount than the total contribution limit. Once your income hits the second, higher income threshold, you may not contribute to a Roth IRA at all.
Alright, so here are those income limitations for 2023…
- If you’re single, your Roth IRA begins to be phased out at $138,000 in annual income. Your ability to fund the Roth IRA is eliminated at $153,000 in annual income.
- If you’re married (and file your taxes jointly, which virtually everyone does) the Roth IRA phase out begins at $218,000 in annual income; you're fully phased out of the Roth IRA at $228,000 in annual income.
If you find yourself close to any of the income limitations, I strongly encourage you to work with tax software or a financial planner because this phaseout math is pretty complex. You can also use a backdoor Roth IRA strategy to get around these limitations, but that’s tricky and I rarely advise folks tread that path without professional guidance.
Traditional IRA Income Restrictions
Believe it or not, the income limitations around Traditional IRAs are even more confusing than those for Roth IRAs.
But there is good news, too: you can always contribute to a Traditional IRA. However, whether that contribution is tax deductible sometimes depends on your income. Deductible means that your contribution reduces your taxable income and results in you paying less in taxes. (Just like business deductions in your practice.)
You only have to worry about these income limitations if either you or your spouse has access to a retirement plan at work. (The word access is important: often it doesn’t matter if you actually participate, but rather if you had access and could participate if you chose to.)
If neither you nor your spouse has access to a retirement plan at work, you can stop here: no need to worry about these rules. Your Traditional IRA will almost certainly be fully deductible regardless of your income level.
So with all that mind-numbing detail as background, here are the two circumstances to watch out for:
- If you’re employed somewhere where you have access to a retirement plan, the deductibility of your Traditional IRA contribution begins to be phased above a certain income level. There is a second, higher income level at which the deductibility of your contribution is fully eliminated. (This phaseout range works just like the phaseout ranges for the Roth IRA, except it impacts only the deductibility of your always-allowed contribution — rather than the ability to make the contribution itself.)
- If you’re single, the deductibility of your Traditional IRA contribution begins to be phased out at $73,000 and is fully eliminated at $83,000.
- If you’re married (and file your taxes jointly as almost everyone does), the deductibility of your Traditional IRA contribution begins to be phased out at $116,000 and is fully eliminated at $136,000.
- If you are married, we have one more test you need to consider. (Sorry!) If you don’t have access to a retirement plan, but your spouse does, then the deductibility of your Traditional IRA contribution may be limited — but now at different, higher income levels. Under this circumstance, the deductibility of your Traditional IRA contribution begins to be phased out at $218,000 and is fully eliminated at $228,000.
Once again, these rules and their math are complex, so if you find yourself near these income ranges, I’d suggest working with a qualified professional (or at minimum using good tax prep software). The above ranges also apply only for 2023 — and are typically increased a bit each year.
That’s a Wrap 🎬
Man, this stuff is confusing.
I’ve done my best to clearly describe these rules. How did I do? I’m not even sure myself haha.
If you still have questions (and I’d be surprised if you didn’t) I’d encourage you to sign up for my next Ask Me Anything “AMA” Office Hours. Totally free and open to any and all therapists looking for the honest thoughts of a fee-only, fiduciary CFP® professional. (That’s me 👋)
Turning Point is a registered investment advisor in the state of California. Please visit turningpointhq.com for important information and additional disclosures. This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes financial, legal or tax advice; a recommendation for purchase or sale of any security; or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Read the full Disclaimer here.