The 3 Types of IRAs
Individual Retirement Accounts (IRAs) provide tax advantages when saving for retirement. There are three different kinds of IRAs:
Traditional IRAs allow you to make contributions with pre-tax dollars.
Roth IRAs are ideal for individuals who anticipate being in a lower tax bracket upon retiring.
Simplified Employee Pension (SEP) IRAs are ideal for small business owners, self-employed individuals and freelancers.
The traditional IRA is one of the most popular retirement saving tools. Its key advantage lies in offering tax deductions on contributions; your contributions and earnings grow tax-deferred until withdrawn at which point you will pay income taxes on them.
Traditional IRAs can be opened at most banks, credit unions and financial institutions as well as online brokerages and investment companies. You have the choice between selecting your investments yourself or using a robo-advisor as part of a more hands off approach.
Rollover IRAs are designed to accept funds from employer-sponsored retirement plans like 401(k)s and 403(bs, when you experience a qualified distribution event, then transfer them directly into either a traditional or Roth IRA for safekeeping. However, this option is only open to people with earned compensation such as wages, salaries, commissions tips or bonuses; self-employed individuals and small businesses can take advantage of SEP IRAs instead for similar benefits.
IRA accounts are flexible financial products that can be opened at almost any financial institution – banks, brokerage firms, mutual funds and insurance companies alike. You can invest your IRA funds in stocks, bonds, CDs and exchange-traded funds (ETFs). Note: certain investments such as life insurance policies and collectibles such as art may not be allowed – please check with your tax advisor first for advice in this matter.
Contributions and earnings made to traditional IRAs are generally tax-deductible in the year they are made, while withdrawals will usually be taxed as current income in retirement. Withdrawals before age 59 1/2 may incur both income taxes and a 10% penalty fee.
Your options for opening an Individual Retirement Account (IRA) include opening one through an online broker or, if you prefer a less hands-on experience, many major brokerages now provide robo advisors that manage IRA investment portfolios at a fraction of what traditional managers would charge. Furthermore, within 60 days you can transfer any IRA money between financial institutions without incurring penalties.
SEPs (Simple Employee Pension Plans) can be created by any employer – from sole proprietorships to corporations. Similar to an IRA, they can be invested in any number of mutual funds, equities, bonds or even FDIC-insured CDs.
SEP contributions are tax deductible on a business’s tax return as either employer contributions or as percentages of employee compensation, while employees do not make contributions directly into their own SEP accounts; rather, they receive distributions from their employer’s SEP without incurring tax consequences – provided these are taken before age 59 1/2 and meet required minimum distribution rules.
Self-employed or small business owners can set up a SEP relatively easily; all it requires is signing up with an intermediary offering SEP IRAs and filling out an IRS form. Contribution limits for SEP IRAs tend to be higher than traditional or Roth IRAs but are typically less than those for larger 401(k) plans.
A SIMPLE IRA is an employer-sponsored retirement account ideal for smaller businesses. Employees contribute pre-tax dollars via payroll deduction and have control over how their funds are invested.
Employers must contribute either 2% of an employee’s annual salary, or match up to 3% of elective deferral contributions on a dollar-for-dollar basis. Plans may limit participation depending on how much employees earned in previous two years and can expect to make this year.
SIMPLE IRAs offer lower IRS contribution limits than Traditional or Roth IRAs, and participants must begin taking minimum distributions at age 72 (or earlier if they are younger than that). However, unlike SEP IRAs, employees can roll their SIMPLE IRA funds over into another retirement plan without incurring an early withdrawal penalty if they wait two years after starting contributions to withdraw them.
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