- IRA accounts let you save for retirement independently, without enrolling in an employer-sponsored plan like a 401(k).
- Tax benefits are a major draw of IRAs for investors.
- There are several different type of IRAs, that vary in eligibility requirements and benefits.
IRA, or Individual Retirement Arrangements, are a popular choice when it comes to investing for retirement. These plans usually offer tax benefits as an incentive to starting to save earlier. Understanding the difference between various IRA plans is critical for helping you choose the plan that’s right for your needs.
What is an IRA?
IRAs are retirement savings plans that offer tax incentives to individuals. Unlike a 401(k) plan, they are not setup by employers, giving individuals more flexibility and control over how their funds are managed. However, there are several different types of IRAs and it’s important to understand the rules and eligibility requirements to decide which plan is right for you.
Benefits of IRAs
A major advantage of IRAs is their tax benefits, which vary depending on the type of IRA you choose. A Traditional IRA, for example, allows you to make tax-deductible contributions, but require you to pay taxes on the withdrawals. Roth IRAs, on the other hand, offer tax-free withdrawals, but require you to pay taxes on your contributions. For those with low to moderate incomes, contributions to IRAs can be eligible for the Saver’s Credit.
Types of IRAs
Anyone under age 70 ½ can contribute to a Traditional IRA, but you must meet certain income requirements to be eligible for the tax benefits. Currently, if you are covered by a retirement plan at work your modified adjusted gross income (MAGI) must be less than $75,000 for individuals and $124,000 for those married filing jointly. The annual contribution limit is $6,000 until you turn 50 and then increases to $7,000. Once you turn 70 ½, you must stop making contributions and begin taking out minimum required distributions from your account. Contributions are tax-deductible, but you will pay taxes on your withdrawals. You may be subject to a 10% penalty if you make withdrawals before you turn 59 ½. Learn more about Traditional IRAs.
The Roth IRA is only available to individuals within certain income limits – a MAGI of $139,000 for single filers and $206,000 for joint filers. If you’re eligible to open a Roth IRA, you will have to pay taxes on your contributions. You may withdraw your contribution at any time and may withdraw earnings tax-free once you reach 59 ½ if the account is at least five years old. In addition, there are certain circumstances where an account owner may qualify for a distribution of earnings before reaching the age limit. Learn more about Roth IRAs.
SEP IRAs are retirement savings plans aimed towards small and medium sized businesses. It offers tax benefits to employees and employers. Contributions to SEP IRAs must be made by employers, and if contributions are made in a given year, they must be made for every eligible individual at the business. Since employer contributions to the SEP IRA are not counted as the employees’ income, employees do not pay taxes on contributions, only on withdrawals. Withdrawal rules are similar to that of the Traditional IRA. Learn more about SEP IRAs.
Designed for companies with fewer than 100 employees, the SIMPLE IRA is meant for smaller businesses that do not want to take on the complex setup of a 401(k). This plan requires employers to make fully vested contributions that match a percentage of employees’ contributions. Employees pay no taxes on contributions, only on withdrawals. The distribution rules are the same as those for a Traditional IRA. Learn more about SIMPLE IRAs.
Self-Directed IRAs are individual retirement savings plans that give investors more flexibility in asset choices than Traditional or Roth IRAs. The account must be held by a qualified trustee, but individuals can control how they want to allocate these alternative investments. Other than life insurance policies and collectibles, account holders are not limited in investment options. Self-Directed IRAs also adhere to the same distribution rules as a Traditional IRA. Learn more about Self-Directed IRAs.
Opening an IRA account
Most financial institutions offer several types of IRA accounts and give you the ability to choose how to allocate your savings across assets. Common options include mutual funds, individual stocks, annuities, bonds, and money market funds. For example, investors can open a Wealthfront account for Traditional IRA, Roth IRA, or SEP IRA.
Nothing in this article should be construed as tax advice, a solicitation or offer, or recommendation, to buy or sell any security. This article is not intended as investment advice, and Wealthfront does not represent in any manner that the circumstances described herein will result in any particular outcome. Financial advisory services are only provided to investors who become Wealthfront clients.
This article is not intended as tax advice, and Wealthfront does not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction. Investors and their personal tax advisors are responsible for how the transactions in an account are reported to the IRS or any other taxing authority.