What Type of IRA Should You Have?
IRAs can be powerful long-term savings tools, yet can often be confusing. Between various types, tax considerations and government jargon it may feel intimidating.
Which type of IRA best meets your needs will depend on where you are in life and career, with traditional, Roth, and self-directed being among the most popular choices.
Traditional IRA
A traditional IRA can provide an ideal supplement to an employer-provided retirement plan and can take advantage of tax-deferred growth potential. You have access to a wide variety of investments within its rules and regulations for maximum tax efficiency.
Withdrawals from traditional IRAs are generally taxed as ordinary income; however, you may be able to avoid taxes by making penalty-free withdrawals before age 59 1/2 for qualified expenses such as purchasing your first home or financing your education expenses. Furthermore, depending on your income and whether or not either spouse has access to an employer-sponsored retirement plan, your contributions could potentially be partially or fully tax deductible.
IRAs offer an effective way to save for retirement, but with many different options and tax considerations as well as government jargon to navigate it can be difficult determining the appropriate type of account for you. Schwab provides tools and resources that can assist with understanding each IRA type’s benefits1.1
Roth IRA
Capital gains and dividends earned within most brokerage accounts are subject to taxes based on your income level, while withdrawals from Roth IRAs may be tax-free provided they meet certain requirements.
Roth accounts can provide substantial tax and penalty savings if you anticipate that top federal income tax rates could rise over time. Withdraw contributions and earnings at any time without incurring penalties. This can be especially advantageous if your tax rates might rise substantially in future years.
Roth IRAs offer more flexibility for those needing early withdrawals for unreimbursed medical expenses or qualified education expenses, although not everyone may need one; those working multiple jobs and incurring large tax bills at year end might benefit more from a traditional IRA that allows them to take tax deductions today and save taxes later. Many IRA providers also provide tools and advice programs to assist investors manage their investments more easily.
Self-Directed IRA
Self-Directed IRAs provide more investment flexibility than traditional retirement accounts. You are permitted to invest in assets like commercial real estate and LLC membership interests that would otherwise not be allowed, offering high potential returns but carrying greater risks than their traditional counterparts. Therefore, it is wise to familiarize yourself with both these investments as well as IRS guidelines for self-directed IRAs in order to avoid tax penalties or disqualification in making decisions regarding them.
Self-directed IRAs allow you to diversify and enhance your retirement portfolio by investing in nontraditional assets like mortgage notes, real estate and tax lien certificates. Such assets can help enhance income stability during retirement as well as leave behind an inheritance for future generations. Furthermore, unlike traditional retirement accounts, self-directed IRAs do not subject themselves to early withdrawal regulations, but minimum distributions may start being taken out at age 72.
Rollover IRA
IRAs typically have lower account and investment-related fees than company 401(k) plans; however, pricing varies widely and you should carefully assess fees to ensure you don’t overpay.
No matter the plan you currently participate in or roll it over into an IRA, taking control of your retirement savings is easy and can provide many tax benefits. Traditional IRAs function similarly to personalized pensions in that they provide significant tax breaks in return for restricted and limited access to funds.
IRAs also provide additional options, including SEP IRAs for small business owners and SIMPLE IRAs for employees with 100 or fewer employees. You can own assets including real estate and precious metals; these investments may better suit your lifestyle and financial goals than what’s offered through traditional 401(k) plans. Furthermore, an IRA gives you flexibility in how you invest your money – as well as freedom to change course at any time.
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