Individual retirement accounts (IRAs) offer a way to save for retirement.
In a general sense, IRAs are dependent on the same basic rule as the retirement account options offered by an employer. IRAs have contribution limits and allow you to withdraw cash without any penalty after the age of 59½.
Likewise, IRAs provide tax benefits—notably, the chance for tax-deferred or tax-free growth. Depending on the type of IRA, contributions may be taxable or tax-deferred, but any earnings grow tax-free. Withdrawals are subject to income tax.
There are two types of traditional tax-deferred IRAs: nondeductible and deductible.
If you don’t have access to another retirement plan through work, and you’re younger than 72 you can contribute money to your IRA and deduct the amount from your taxes.
If you do have access to a 401k or another retirement plan through work, your contribution is only fully deductible if your adjusted gross income is less than $61,000 for an individual, and less than $98,000 for a married couple.
Either way, earnings from the account are tax-deferred until they are withdrawn. Mandatory distributions begin after age 72.
While contributions to traditional IRAs are usually tax-deductible, contributions to Roth IRAs are not.
With a Roth IRA, you contribute using after-tax dollars. Earnings accrue tax-free, and withdrawals are tax-free (after 5 years and the age of 59.5).
Additionally, Roth IRAs do not have a required minimum distribution (RMD). If you don’t need the cash, you aren’t required to withdraw it from your account.
Savings Incentive Match Plan for Employees (SIMPLE) IRA is a retirement savings plan utilized by small businesses and even the self-employed.
With this plan, employers may opt for a non-elective contribution of 2% of an employee’s salary, or match an employee’s contribution dollar-for-dollar up to 3% of their salary.
A simplified Employee Pension (SEP) IRA is similar to a traditional IRA for small business owners and self-employed individuals.
Employer contributions to this IRA are tax-deductible and can be made on a discretionary basis.
For the employees, contributions are tax-deductible and investment income builds tax-deferred up until retirement when distributions are taxed as income.
In addition, SEP IRAs often offer higher annual contribution limits.
Spousal IRAs are IRAs that are used by married people. They are regular traditional or Roth IRAs, set up in the name of the individual – not joint accounts.
With a Spousal IRA, a working spouse is permitted to contribute to the retirement savings of a nonworking spouse.
Here, there’s an exception to the provision that a person must be earning an income to qualify for an IRA.
One condition for using a Spousal IRA is that the contributing spouse’s income must equal or be greater than the combined IRA contributions.
Inherited IRAs, also called beneficiary IRAs, are accounts that manage the assets of a person who died.
Inherited IRAs can be funded from any IRA: simple, Roth, traditional, and SEP-IRAs. Also, it can be created out of the cash from the deceased person’s 401(k) plan.
Rules for handling an inherited IRA are different depending on whether the inheritor is a spouse or non-spouse, and the tax laws involved with an inherited IRA are quite complex.
Rollover IRAs allow you to transfer funds from your former employer-sponsored retirement plan into an IRA.
This allows you to preserve your retirement assets that have a tax-deferred status without having to pay current taxes or early withdrawal penalties during the transfer period.
There is often a wider range of choices for investment when moving away from an employer retirement plan – including bonds, stocks, and ETFs to name a few.
Education IRA (formerly known as Coverdell Education Savings Account)
Education IRAs are tax-advantaged accounts for qualified education expenses.
It’s an IRA that allows parents and guardians to fund the educational costs of a child through contributions to a custodial account or trust.
Tax-free withdrawals from this type of IRA are allowed as long as the funds are used for qualified educational expenses.
A nondeductible IRA is an IRA not entitled to tax deductions – contributions are made with after-tax dollars. However, earnings and interest accumulate tax-deferred until withdrawn.
This is a type of Roth or traditional IRA that is administered by a custodian or trustee, but is managed by the account holder.
However, the types of assets you possess in the account make a self-directed IRA different from other types of IRAs. In addition to stocks, bonds, ETFs, mutual funds, and CDs, the account holder can invest in commodities, precious metals, tax liens, limited partnerships, and real estate
Consult a qualified financial professional regarding your IRA options. There are many choices available, and it is vital that you understand how your choice could affect your financial situation. No one IRA is the “right” IRA for everyone, so do your homework and seek advice before you proceed.
Schedule an appointment with an advisor to discuss your retirement plan.
Editor’s note: This article was originally published in May of 2018. It has been updated for relevancy and accuracy.