Which IRA should I Use
Many are familiar with the term IRA, or Individual Retirement Account, but they do not know exactly what they are or what purpose they serve. IRAs are not investments themselves, but rather they are made to hold stocks, bonds, mutual funds, and other assets. Unlike other retirement accounts that your employer must provide for you, often you can open IRAs on your own. There are several different kinds of IRAs and each has their own set of rules.
Traditional IRAs are the most well known IRA. They are tax-deferred, which means that you make contributions with pre-tax money. But you do not have to pay the taxes until you withdraw the money. Besides being tax-deferred, Traditional IRAs are also tax deductible. You are allowed to deduct a certain amount of your contributions from your taxes if you meet certain requirements. To be able to deduct the whole amount from your taxes you must be younger than 70 ½ and have no retirement plan at work. If you meet these requirements and your spouse does not work, they can also deduct the full contribution amount from their taxes. If you do have a retirement plan at work and you want to be able to deduct the full amount, your adjusted gross income must be less than $98,000 for a married couple and less than $61,000 for an individual. If you are not covered under a retirement plan at work, but you and your spouse have a combined income of $184,000 or more you cannot take the deduction. It is important to understand all of the contribution rules so that you can utilize your IRA to the full. If you are confused about any of these limits take with a Certified Financial Planner®.
Another thing important to know about Traditional IRAs is that you cannot take any distributions under the age of 59 ½. If you do you will have to pay a 10% penalty in addition to the taxes that you will owe. You are also required to start taking distributions in the year you turn 70 ½ known as RMD’s or Required Minimum Distributions.
Roth IRAs are tax-free investments. You fund them with after tax money (or money that you already paid taxes on). Since you already paid the taxes, you do not have to pay any when you withdraw money from the account. However, like traditional IRAs, you will have to pay a penalty if you take a distribution before you turn 59 ½. If you wish to start contributing to a Roth IRA you must meet certain requirements. You must have taxable income and your modified adjusted gross income must be less than $194,000 for married couples filing jointly; less than $132,000 for people filing as single, head of household, or married filing separately if they have not lived with their spouse at all during the year; and less than $10,000 if you are married filing separately but you have lived with your spouse during the year. One benefit of Roth IRAs is that there are no required minimum distributions, so your money can continue to grow in the account for as long as you want.
SEP stands for Simplified Employee Pension. This is a type of Traditional IRA for self-employed persons or small business owners. Any business owner with one or more employees or anyone who makes freelance income can set up and SEP. These contributions are tax-deferred and deductible for business or individual contributions. SEPs have high contribution limits. You can contribute 25% of income or $53,000, whichever is less. This contribution limit is in addition to any Traditional or Roth IRA contributions you make during the year. Any employees who desire to participate must be at least 21 years of age and have worked at the business for 3 of the last 5 years, and received a minimum of $600 from the employer during the year. With SEP IRAs the employer does not have to make contributions each year, but when they do decide to contribute they must contribute to their own account, as well as all to all eligible employees accounts.
SIMPLE stands for Savings Incentive Match Plan for Employees. This is another type of Traditional IRA for small business owners or those who are self-employed. Just like SEP IRAs, the contributions are tax-deferred and deductible. However, unlike SEPs, employees are allowed to make their own contributions. Also, the employer is required to make yearly contributions for each participating employee. This contribution can either be a dollar for dollar match of up to 3% of the employee’s salary or a flat 2% of their salary. This contribution must be made whether or not the employee chooses to participate. If an employer desires to set up a SIMPLE IRA they must have less than 100 employees and the employees’ cannot have any other employer-sponsored retirement plan. Employees are allowed to contribute up to $12,500 a year. Any employee aged 50 or older is allowed an additional $3,000 “catch-up” contribution amount.
This is just a quick overview of 4 different kinds of IRAs. If you would like more in-depth information or you would like help setting up an account of your own contact a Registered Investment Advisor who can guide you through the process.