Types of Individual Retirement Account (IRA)

October 5, 2022

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What Is (IRA) Individual Retirement Account?

An (IRA) individual retirement account is your personal savings plan that offers tax advantages. Contributions to an IRA are typically made with after-tax money, which means that the money you contribute has already been taxed. With a traditional IRA, you can defer taxes on your investments’ earnings. With a Roth IRA, you pay taxes on the money you contribute, but earnings can grow tax-free.

Types of IRA

Traditional IRA

A Traditional IRA account allows you to set aside money for retirement and enjoy tax-deferred growth. With a Traditional IRA, you may be able to deduct your contributions from your taxes each year, giving you a nice little tax break now. When you retire and start taking distributions from your account, those withdrawals will be taxed as ordinary income. So, while you don’t get a tax break on the money you take out of your Traditional IRA in retirement, you get a break on the money you put in.

There are a few limitations to how much you can contribute to a Traditional IRA each year. For 2020, the contribution limit is $6,000 if you are under age 50. But if you are 50 or older, you can contribute up to $7,000.

You may not deduct the total amount of your Traditional IRA contribution if a retirement plan covers you (or your spouse, if filing jointly) at work and your income exceeds certain levels. But even if you can’t deduct your contribution, the money can still grow tax-deferred until you retire.

You usually don’t need to pay taxes on the money in your Traditional IRA until you start taking distributions. And you can leave the money in your account as long as you want. You will, however, have to start taking required minimum distributions (RMDs) starting at age 72.

The benefit of a Traditional IRA is that you get a tax break on your contributions now, and you don’t have to pay taxes on your account until you retire. The downside is that you’ll pay taxes on your withdrawals in retirement.

Roth IRA

The Roth IRA is named for Senator William Roth, who introduced the legislation that created it in 1997. Thanks to their tax-advantaged status, Roth IRAs have become one of the most popular retirement savings options.

The Roth IRA account is a retirement saving in which you contribute after-tax dollars and withdraw the money tax-free in retirement. This makes it an attractive option for savers who want to minimize their tax liability in retirement. Income limits are associated with contributing to a Roth IRA, so it may not be an option for everyone. There are a few things to know about Roth IRA contributions:

You can contribute up to $6,000 annually ($7,000 if you’re 50 or older).
Your contribution limit is reduced if you have a retirement plan at work and your income exceeds certain thresholds. Your contribution limit is generally zero if you’re married and filing separately.

Roth IRA contributions are not tax-deductible. The money you contribute to a Roth IRA has already been taxed, so you can withdraw it tax-free in retirement. This is unlike a traditional IRA, where you pay taxes on the money you withdraw in retirement. You could contribute to a Roth IRA at any age, as long as you have earned income.

Moreover, there are no mandatory distributions from a Roth IRA, so you can leave the amount in the Roth account to grow tax-free for as long as you want. This makes it a good option for estate planning. You can withdraw your Roth IRA contributions at any time without penalty. This is not the case for earnings, which are subject to taxes and penalties if withdrawn before age 59 1/2.

SEP IRA

SEP IRA is a retirement savings plan for small business owners and self-employed individuals. This type of IRA allows you to set aside a portion of your income each year into a tax-deferred account. The money in your SEP IRA can then be used to provide income during retirement. The topmost benefit of a SEP IRA is that it allows you to save for retirement without making regular contributions like a traditional IRA.

Another benefit is that the money in your SEP IRA can grow tax-deferred until it is withdrawn. This means you will not have to pay taxes on the interest earned on your account until you withdraw in retirement.

Simple IRA

A Simple IRA account is a retirement savings plan that allows employees of small businesses and self-employed individuals to contribute to a traditional individual retirement account (IRA) on a tax-deferred basis. Employees eligible to participate in a Simple IRA plan can make salary deferral contributions of up to $12,500 per year ($15,500 if the employee is 50 or older). Employers with 100 employees or fewer can establish a Simple IRA, including self-employed individuals.

The employer must make a matching contribution of up to 3% of the employee’s salary, or a nonelective contribution of 2% of each eligible employee’s pay, regardless of whether the employee makes salary deferral contributions.

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Benefits of IRA

There are several benefits to using an IRA as part of your retirement savings strategy, including:

Tax Advantages: Traditional IRAs offer tax-deferred growth, meaning you won’t pay taxes on the money you contribute or the earnings it generates until you withdraw it in retirement. Roth IRAs offer tax-free growth, meaning you won’t pay taxes on the money you contribute or your earnings when withdrawing it in retirement.
Flexibility: You can choose how you want to invest your IRA funds, including stocks, bonds, mutual funds, and ETFs.
Portability: If in case you change jobs or retire, you can take your IRA with you.