IRA; Everything You Need to Know on Individual Retirement Accounts
IRAs, unlike the popular 401K or the lesser known 403B are individual accounts, not set up by employers. In fact, IRAs are often used by self-employed individuals. That being said, there are several types of IRA accounts, each with eligibility restrictions based on your income or employment status.
- Traditional IRA – The word traditional seem self-explanatory, but if you are trying to figure out which IRA suits you, you need a little more description. A Traditional IRA is an Individual Retirement Account into which you contribute pre-tax or after-tax dollars and which permits your money to grow tax-deferred. After age 59 ½ the withdrawals are taxed as current income. That being said, the IRS has listed a contribution cap in the year 2016 in the amount of $5,500 up to age 50, and $6,500 if you are 50 or older. Be aware that excessive contributions, which the IRS has defined on their site as either more dollars than the contribution limit – such as the amounts stated previously, IRA contributions made to your traditional IRA at age 70 ½ or older, or an improperly rolled over contribution to an IRA. Our licensed Investment Design advisors can answer more questions on the tax rates, or you can review the IRS retirement plan site here. When you reach the age of 70½ you must also begin receiving required minimum distributions.
- Deductible IRA – Allows you to deduct your contributions on your tax return, lowering your tax return and basically yielding a refund on the taxes you paid earlier in the year.
- Nondeductible IRA – Is funded with your after-tax dollars and cannot be deducted on your tax return. The Deductible IRA seems like the better option, but the situation depends on your income, filing status and which other benefits you already receive.
Roth IRA – A Roth IRA is funded with after-tax dollars, allowing your money, which you have already paid taxes on, to grow tax-free, and to be withdrawn at retirement with no taxes due. There is another benefit: you may withdraw your money at any time free of penalties and taxes if it is for a qualifying reason. (there are penalties for funds withdrawn before 59 ½ years old if it is not for a qualifying reason.) Also, a Roth IRA that was converted from a traditional IRA must season for 5 years before you can withdraw funds free of penalties. You can leave your money untouched in a Roth IRA as long as you like, with no required distributions at any age. The flexibility of the Roth IRA is seen as its biggest advantage – access to the funds without all of the penalties and no limit on how long you can keep the fund.
Roth IRA contributions limitations are based in the income levels. You may contribute to a Roth IRA if your income is less than $194,000 if you are married filing jointly or less than $132,000 if you are single, head of household, or married filing separately AND did not live with your spouse at all during the prior year. You may also contribute to a Roth IRA if your income was less than $10,000 if you’re married and fling separately but living together at any time during prior year.
- SEP IRA – A Simplified Employee Pension Individual Retirement Account in which the contributions, which are tax-deductible for the business or individual, go into a traditional IRA held in the employee’s name. Employees of the business cannot contribute – the employer does. Like a traditional IRA, the money in a SEP IRA is not taxable until withdrawal. The main benefit over a traditional or Roth IRA is that the contribution limit is higher. This year, 2016, business owners can contribute up to 25% of income or $53,000, whichever is less.
- Simple IRA – Simple IRAs are easier to set up than profit sharing plans or 401K plans. Employees can still contribute, unlike SEP IRAs. In short, a Simple IRA is a savings incentive match plan for Employees. It is a type of Traditional IRA designed for Small Businesses and self-employed individuals. Your contributions are tax deductible, and tax deferred until you are ready to withdraw upon retirement. The employer is required to match the employee’s contributions either dollar for dollar up to 3% of salary or 2% of pay flat contribution regardless of whether employee contributes too. The contribution limits are higher than with Traditional IRAs or Roth IRAs. As an employee in 2016, you could contribute a percentage of your compensation up to $12,500 under 50 years of age, or up to $15,500 if 50 years of age or more for purposes of catch up.
With as little as $1,000, you can open an (Individual Retirement Account). It can be used to complement a 401k or 403b plan if you have that option at work, or as a stand-alone method of savings for retirement. Though many think an IRA is an investment account, it is actually a savings vehicle, or the “safe” holding the stocks, bonds, mutual funds and other assets, allowing you to save while enjoying tax benefits on the funds. Each type of IRA has restrictions, which is why you should contact your advisor to make sure you are informed and understand the restrictions on each.