Are There Two Types of IRA?
Individual Retirement Accounts (IRAs) provide tax-advantaged savings solutions with flexible investment opportunities.
Traditional IRAs allow you to postpone paying taxes until withdrawals begin in retirement.
Roth IRAs allow you to withdraw funds tax-free if certain criteria are met.
Traditional IRA
A traditional IRA allows for tax-deferred growth on investment earnings until withdrawal in retirement, so anyone with earned income can contribute. There are annual contributions limits set forth by the IRS; contributions through Simplified Employee Pension (SEP) IRA or Savings Incentive Match Plan for Employees (SIMPLE) are often tax-deductible.
No matter which IRA type you select, both are designed to grow retirement savings tax-deferred. But depending on your circumstances and long-term plans, one might provide more value.
Traditional IRAs may provide potential tax savings now and offer greater flexibility than Roth IRAs when investing for retirement, including the freedom to select almost any stock, bond, mutual fund or ETF available to invest.
Roth IRA
No matter where you stand in terms of savings or retirement planning, the Roth IRA is an effective and flexible account option to consider. These tax advantages make the Roth IRA an appealing way for many individuals to save for retirement.
Roth IRAs provide an interesting alternative to traditional IRAs and 401(k) plans in that contributions generally get an up-front tax deduction and withdrawals can generally be tax-free in retirement. Here, contributions incur income tax while withdrawals typically remain free from any future tax burden.
Roth IRAs allow your funds to compound and grow over time while also providing you with a tax-free financial safety net in case of emergency. Contributions (but not earnings) may be withdrawn at any time without incurring penalties, giving Roth IRAs greater flexibility than other retirement accounts can. Heirs of original owners are eligible to withdraw without penalty as long as certain rules are adhered to – making Roths particularly suitable for individuals in lower tax brackets than their original owner.
SEP IRA
SEP IRAs were specifically created to offer small business owners and the self-employed an effective retirement savings vehicle, with easy set-up and administration and high contribution limits when compared to traditional and Roth IRAs.
As with a traditional IRA, contributions to a SEP IRA are tax-deductible contributions from employers; up to 25% of eligible employee compensation may be contributed up to an annual compensation limit ($345,000 for 2024 and $350,000 in 2025).
SEP IRAs are specifically tailored to help businesses without employer-sponsored plans provide retirement benefits to their employees. Available to sole proprietors and all types of partnerships, but typically preferred by smaller-business owners with few or no employees. Employers can tailor contributions depending on employee performance – increasing them when years are good and decreasing them during bad ones if desired. Contributions can also be claimed both during their year of contribution as well as the following tax filing year depending on compensation type.
SIMPLE IRA
The Savings Incentive Match Plan for Employees, or SIMPLE IRA, enables small businesses to contribute towards employees’ retirement savings in a tax-deferred account. Employees may contribute up to $16,000 (increased from $15,500 in 2022) each year and are eligible for catch-up contributions of $3,500 after 50. Employers have two options when contributing: they may match employees’ contributions dollar for dollar up to 2% of compensation or make nonelective contributions of their own accord.
SIMPLE IRAs offer several distinct advantages over more conventional employer-sponsored retirement plans like 401(k)s: matching employee contributions aren’t subject to vesting periods – meaning when an employee leaves their current company they can take with them all of the matching contributions that have accrued since joining.
Thus, SIMPLE IRAs may be more cost-effective for small business owners seeking to maximize contributions for rank-and-file employees with lower net incomes than 401(k) plans do. Furthermore, these accounts offer employees more investment flexibility.
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