Are There Two Types of IRA?
Individual Retirement Accounts (IRAs) can be a beneficial retirement tool for those without access to workplace retirement options. While each IRA comes with its own set of rules and restrictions, Roth and traditional IRAs offer distinct tax advantages for savers.
Traditional IRAs provide tax-deductibility and enable earnings to accumulate tax-free until withdrawals at retirement age are taken out, though their tax treatment depends on individual investors and income levels.
Traditional IRA
Traditional IRAs allow you to invest in stocks, bonds and mutual funds tax-deferred until withdrawal – typically upon retirement. Contributions may even qualify for tax deductions depending on your income and tax-filing status; once age 72 has been reached however, required minimum distributions (RMDs) from your IRA must begin following an IRS formula.
If you withdraw money from a traditional IRA before age 59 1/2, an early withdrawal penalty of 10% applies. Therefore, it’s essential to save for retirement with a well-diversified portfolio and save as early as possible for that momentous day of independence!
Roth IRA
Roth IRAs allow investors to invest in securities similar to Traditional IRAs, such as bonds, stocks, mutual funds and exchange-traded funds. Withdrawals from Roth IRAs are tax-free as long as certain requirements are fulfilled. Online brokerages offer services that make opening a Roth IRA easy – some providers even provide the option to bundle an account with checking or savings accounts! When selecting your provider be mindful of fees and minimum accounts required.
To be eligible to make contributions to a Roth IRA, you must be making earned income. Salary, hourly wages, bonuses, tips, commissions and self-employment income all count toward eligibility for Roth contributions while investment income, Social Security benefits, unemployment compensation or alimony do not. If you anticipate being in a higher tax bracket when retiring, Roth accounts may be ideal; the IRS offers an online calculator that can help calculate your Modified Adjusted Gross Income (MAGI). This metric determines whether or not contributions can be deducted.
SIMPLE IRA
A SIMPLE IRA is a retirement plan that enables employers to contribute 3% of an employee’s salary as their contribution; employees can then make additional contributions using payroll deductions, with employers matching them dollar for dollar until reaching 3% of total compensation.
SIMPLE IRAs offer small businesses with few employees an easy way to set up and administer retirement savings plans that provide tax credits as well. Furthermore, unlike traditional 401(k) plans which involve vesting schedules or waiting periods before contributions become actual ownership of employer contributions made directly through SIMPLE IRAs.
Though withdrawals must be completed before age 59 1/2 or face a 10% penalty, exceptions exist if withdrawing money to pay for your first home, higher education expenses or qualified medical expenses.
Taxes
With a Traditional IRA, you can reduce your taxable income by deducting contributions on your federal tax return and defer taxes until retirement when making withdrawals – although any early withdrawals could incur ordinary income taxes and an additional 10% penalty tax.
Roth IRAs allow you to contribute after-tax dollars and have them grow tax-free until retirement when withdraws are subject to taxes. This account would be ideal if you anticipate having higher tax brackets during that time.
Your options for opening an Individual Retirement Account (IRA) include most banks, brokerage firms, mutual fund companies and insurance agencies. When looking for the ideal deal you should compare management fees, commissions and minimum opening requirements to find the most competitive deal. You could even choose to manage it yourself and watch for prohibited items like collectibles (with some exceptions such as heirlooms, antiques, coins gems and stamps).
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