If you’re planning to save money for your golden years, you may have already given some thought to opening an individual retirement account (IRA).
A popular misconception about individual retirement accounts is that they are investments. However, an IRA—in and of itself—is not an investment. When you open an IRA, you’re effectively setting up an account that acts as a holder for your assets. Once you deposit assets into your IRA, your provider will make investment decisions in accordance with your terms, needs, and desires.
Different Types of IRAs
Many people are aware of the two most common types of IRAs: traditional IRAs and Roth IRAs. However, there are several other options available for people who have certain goals or meet specific criteria. You can choose to invest your retirement savings in a:
- Traditional IRA
- Roth IRA
- SEP IRA
- Nondeductible IRA
- Spousal IRA
- SIMPLE IRA
- Self-directed IRA
Here, we explain the differences between each type of IRA, as well as the benefits and drawbacks of each.
As the name suggests, the “traditional” IRA has long been the most popular tax-advantaged retirement account. In fact, traditional IRAs were established by an act of Congress in 1974. Among the main benefits of traditional IRAs are:
- Up-front tax breaks and deductions of up to $6,000 per year
- A special “catch-up contribution” for anyone who sets up an IRA past the age of 50
- Non-taxable investment earnings, provided you don’t withdraw any funds or assets from the IRA
Once you retire, your IRA withdrawals are taxed based on your post-retirement bracket. This makes traditional IRAs a good option for people who think they’ll be earning less money or paying fewer taxes than they were when they opened their account.
The Roth IRA provides a rather different set of benefits from its more traditional counterpart. Among the most critical differences is that contributions to a Roth IRA are not immediately tax-deductible. The key features of a Roth IRA are:
- Tax-free withdrawals once you’ve retired
- Fewer penalties for people who make premature withdrawals
However, individuals can only contribute up to $6,000 per year to their Roth IRA; if they’re over 50, then they can put in $7,000 per year. People who think they’ll be in a higher tax bracket after retirement are best served by a Roth IRA since they can make many withdrawals tax-free.
SIMPLE (Savings Incentive Match Plan for Employees) IRAs can only be used by businesses with 100 or fewer workers—including self-employed business owners or entrepreneurs. Both employers and employees can make matching contributions to a SIMPLE IRA. In many cases, employers are obligated to make matching contributions up to a certain percentage. While SIMPLE IRAs have the benefit of higher annual contribution limits than a traditional or Roth IRA, they may fall short of what can be offered by a regular 401(k).
Here, “SEP” stands for simplified employee pension. Although SEP IRAs are still a form of IRA, the account is set up and funded by an employer for its employees. While individual employees cannot contribute to a SEP IRA, annual contribution limits—set as a percentage of salary—can reach into the tens of thousands of dollars.
If you already have an employer-provided retirement plan, there’s a chance your income or intended contributions may exceed the Internal Revenue Service’s IRA limits. But that doesn’t mean you can’t still open an IRA! You can—but your contributions won’t be tax-deductible. Nevertheless, the IRS offers several incentives, such as:
- Tax deference on investment gains
- No taxes on the IRA principal since it was established with already-taxed funds
If you don’t quite fit the bill for a traditional or Roth IRA but still want to plan for retirement, talk to a wealth management attorney about whether a nondeductible IRA would work for you.
Anyone who seeks to open an IRA must typically be employed. However, some individuals who are married but either earn no income or very little income can still open an IRA with their partner, so long as they file a joint tax return. Contribution limits to a spousal IRA are the same as for a traditional or Roth IRA.
If you’re not comfortable trusting a bank or financial institution with your assets, you have the option of establishing a self-directed IRA. Such IRAs can be set up akin to either traditional or Roth IRAs. Furthermore, the same contribution and taxation rules which apply to traditional and Roth IRAs also apply to self-directed IRAs. However, there are some restrictions on how you can run a self-directed IRA, as well as what you can put into it.
When you establish a self-directed IRA, you’re actually entitled to invest more types of assets than other IRA investors. However, you will have to name a trustee or custodian for your self-directed IRA. You must also abide by specific laws and restrictions: you cannot, for instance, add a life insurance policy to your self-directed IRA, and neither can you perform “self-dealing” transactions, such as making payments to your own businesses.
What to Consider
With so many options available, choosing the right IRA can be a difficult task. After all, which account is best for you depends on a variety of different factors, including:
- Your age
- Your marital status
- How much money you make
- If you’re employed, a contractor, or have your own enterprise
- Whether your job offers any IRA benefits
If you want to protect your future and ensure you have the means to stay comfortable in retirement, remember that an IRA is only one part of a comprehensive plan. When it comes to retirement planning and wealth management, there’s no one-size-fits-all solution: after all, you’re as unique as your money is valuable.
Contact Us Today
Before jumping into an employer-sponsored retirement plan or deciding to fund your own self-directed IRA, send us a message or give us a call at 870-275-4304. We offer wealth management consultations and can help you create an effective retirement plan that centers on your individual needs, goals, and aspirations.