Saving your hard-earned money into an individual retirement account (IRA) can help tremendously in saving for your retirement. Data from the Congressional Research Service Department reveals that in 2019, about 25% of U.S. households owned IRAs1. For those who haven’t yet established an IRA and are not sure which type of IRA they should start with, this blog post is for you!
To help you sift through the noise, I cover 6 different types of IRAs:
1) Traditional IRA, 2) Roth IRA, 3) Spousal IRA, 4) SEP IRA, 5) Non-Deductible IRA, and 6) SIMPLE IRA.
If you want even more direction, schedule a meeting with Tori or Alex and they will talk through which one makes sense for you!
Traditional IRA
Brief History: The IRA was first authorized by the Employee Retirement Income Security Act of 1974. It’s one of the most recognizable accounts used to fund retirement.
Contributions: Fund up to $6,000 in 2022, with an extra $1,000 catch-up contributions for those over the age of 50.
Benefits: Contributions may be deductible, which allows you to lower your taxable income for the year.
Drawbacks: Traditional IRAs are subject to Required Minimum Distributions (RMDs) once the owner turns 72. The ability to deduct contributions from income for single filers who make over $68,000 who contribute to traditional IRAs and have an employer sponsored plan will phase out completely once income reaches $78,000. You have to wait to access the money penalty free until 59½.
Tax Implications: Growth and earnings are taxed at your tax rate when you take the money out of the account after 59½.
Typically Best Suited: Individuals who are in a higher tax bracket now who might be in a lower tax bracket during retirement. Also, for those who do not have access to an employer sponsored retirement plan (401k, 403b, 457).
Roth IRA
Brief History: Roth IRAs were introduced back in 1998 and named after the late Delaware Sen. William Roth. Lately, Roth IRAs have been all the buzz since we entered a historically lower tax environment in 2018 due to the Tax Cuts & Jobs Act that passed in 2017.
Contributions: Funded up to $6000 in 2022, with an extra $1000 catch-up contributions for those over the age of 50.
Benefits: By contributing after tax money into this account, any earnings on investments are tax free as well.
Drawbacks: You are not able to deduct contributions from income. The funds are locked up for at least 5 years (not including solely your contributions). If an individual’s modified adjusted gross income is over $129,000 for 2022, they will not be able to contribute to a Roth IRA.
Tax Implications: The withdrawals that you make after age 59½ (if you’ve had the account for over 5 years) are 100% tax free.
Typically Best Suited: Individuals who might be in a lower tax bracket currently and are expected to be in a higher tax bracket in retirement.
Spousal IRA
Brief History: This is essentially a traditional IRA that the IRS allows spouses to contribute to if they are not working, but the other is.
Contributions: Funded by either pre-tax or after-tax contributions up to $6,000 in 2022, with an extra $1,000 catch-up contributions for those over the age of 50.
Benefits: Allows married couples with just one income to save more toward retirement accounts and save for future goals.
Drawbacks: The spouse opening this account must be a non-working spouse and couples must file a joint tax return.
Tax Implications: Depending on the type of contribution (pretax or Roth), please see Traditional IRA and Roth IRA tax implications above.
Typically Best Suited: For lower-income or non-working spouses married to someone who has earned income.
SEP IRA
Brief History: 1978’s Revenue Act implemented the Simplified Employee Pension IRA (SEP IRA), which established a contributory retirement account, primarily for small businesses.
Contributions: Funded with pre-tax dollars and the lesser of up to 25% of employee compensation or $61,000 in 2022. Contributions are deductible, which allows you to lower your taxable income for the year.
Benefits: Contribution amounts are exponentially more than that of a Traditional or Roth IRA.
Drawbacks: You must be a sole proprietor to open a SEP IRA. No catch-up contributions allowed for workers over age 50. Employees are only able to contribute to this account if they have worked for the employer in at lease 3 of the last 5 years and must have earned at least $600 in compensation during the year.
Tax Implications: These funds are taxed at the tax rate you are in when you withdraw your funds.
Typically Best Suited: For small-business owners who do not want to start up a conventional retirement plan, want to save heavily into their retirement contributions, and receive tax deductions on contributions made for employees.
Non-Deductible IRA
Brief History: This is essentially a Traditional IRA that you can contribute to; however, you will not be able to deduct contributions from your taxes.
Contributions: Funded up to $6000 in 2022, with an extra $1000 catch-up contributions for those over the age of 50.
Benefits: Individuals will still be able to invest money for retirement with the perk of tax-deferred growth on earnings within the account
Drawbacks: No tax deductions on income.
Tax Implications: Taxes on earnings will be at the current tax rate during distribution. No taxes on the principal (what you contributed).
Typically Best Suited: For those who don’t qualify to contribute to a Roth IRA or a Traditional IRA that you’re eligible to deduct from.
SIMPLE IRA
Brief History: In 1996, the Small Business Job Protection Act implemented the Savings Incentive Match Plan for Employees (SIMPLE IRA). A SIMPLE IRA plan provides small employers with a simplified method to contribute toward their employees' and their own retirement savings. Employees may choose to make salary reduction contributions and the employer is required to make either matching or nonelective contributions.
Contributions: Funded by pre-tax dollars that will lower taxable income.
Benefits: The annual contribution limit for a SIMPLE IRA is $14,000. For employees, employers are required to match contributions up to 3% or contribute a fixed amount of 2% of each eligible employees’ compensation.
Drawbacks: Contribution limits are lower than 401(k)s (another alternative to an employer sponsored plan). Early withdrawals from SIMPLE IRAs within the first 2 years of funding the account may be subject to a 25% penalty (on top of ordinary income tax).
Tax Implications: These funds are taxed at the tax rate you are in when you withdraw your funds.
Typically BestSuited: For smaller companies with fewer than 100 employees.
I hope this blog post has helped you sift through the noise and narrow down which IRA might fit your needs best! If you have any other questions on IRAs or would like to get your own IRA started, please schedule an appointment with Tori or Alex HERE!
Best,
Brandon
https://www.irs.gov/retirement-plans/individual-retirement-arrangements-iras
https://sgp.fas.org/crs/misc/R46635.pdf