We all want to do our best to plan for the future. Whether it is saving for a child’s college, or putting away some cash for retirement or a rainy day, we want to get the most from our savings.
For most of us, the best way to plan for retirement is with an IRA. There are several different types of IRAs, but the two you will most often hear about are the traditional IRA and the Roth IRA.
First, let’s look at the difference between in the two types of IRAs.
Traditional IRA: In the traditional IRA, income you invest into the IRA is tax deductible, and you earnings grow tax-free until you take the money out down the road, at which point the money will be taxed at your ordinary tax rate.
Roth IRA: Unlike a traditional IRA, contributions made into a Roth IRA are not tax deductible. The difference is that when you withdraw the money in the future, assuming it has been open over 5 years and you are older than 59 ½, the money, and earnings are tax-free.
One thing to remember is that in both cases, you are looking at a 10% penalty if you pull out the money early.
For both traditional and Roth IRAs, the 2012 limit on the amount you are able to contribute is $5,000, but that number will increase to $5,500 in 2013. For many of us, that is as much or more than we would contribute anyway. For some there is the desire and ability to contribute more than $5,500 a year to an IRAs. While that’s not actually allowed, there are a couple of ways to generate extra cash in your account without going over the contribution limit.
Dividends are a good way to add extra cash to your IRA each year. The income you earn from dividends is not counted against your contribution limit, so they act as a nice addition to the money you are already setting aside. Some people prefer to set their IRAs to automatically reinvest their dividends, while others prefer to simply receive the cash and then decide what do with it later. Either way, you are getting the same amount of extra income into your portfolio, but if you opt to go with cash, you will have a little extra each dividend cycle to put into other investments.
A second easy way to add some extra cash to your IRA is to sell out-of-the-money calls against your positions. This is known as a covered call. You should first make sure your IRA is approved for covered calls. This is the lowest level of options trading under the brokerage industry’s five-level qualification system. If your IRA is not initially approved to trade options, you should contact your brokerage firm to make that change.
Setting up a covered call is a fairly easy process; the only requirement is that you need to own at least 100 shares of the underlying security. Selling a call obligates you to sell your shares at the strike price of the option contract so be sure to select a call at a level at which you would be willing to sell the stock. If you sell a call and the stock doesn’t rise to the level of your strike price by expiration, you get to keep the premium you made from the sale of the call as well as your stock. You can do this over and over again, generating a little extra cash each time.
If done right, this will add a steady stream of cash to your portfolio that won’t count toward your contribution limit. The other advantage is that even if the stock does trade above your strike and you are forced to sell your stock, you have removed emotion from your trade. You take your profit and move on to the next trade.
If you want to learn about selling calls while making money from the strategy, InvestorsObserver‘s Covered Calls Portfolio is a great place to start. You’ll get trade ideas, managed from open to close, from our experienced team of analysts.
Whether you go with dividend investing, selling out of the money calls against your stocks, or both, you can add a steady stream of cash into your retirement account without bumping into the annual contribution limit.