The individual retirement account (IRA) is a method for saving money in either a tax-free or tax-sheltered manner. There is a handful of different types of IRAs with each having its own rules, contribution limits, and benefits for the account holder. The IRA Explained.
When you establish your IRA with a brokerage firm, it allows you to invest your IRA funds in various funds, such as mutual funds, bonds, real estate, and stocks. One of the most popular investment product is the annuity. Here we will cover the various types of IRAs and discuss the fundamentals for each.
The Traditional IRA Explained
The traditional IRA permits you to deposit before-tax earnings in your account. These investments are for distribution after you reach your age of retirement. You invest funds and obtain a tax deduction, and your funds are sheltered from income taxes until you begin making withdrawals at retirement time. The strategy is that you will not withdraw the investments until you quit working and retire, so the distribution you get from your IRA will likely be taxed at a lower rate.
Important aspects of this type of IRA are:
- If you withdraw any of the funds in your account before you turn 59 ½ years old, there will be a stiff penalty of 10% over and above your normal tax liability.
- You are required to begin withdrawing from your IRA when you are 70 ½
- The contribution limit for a traditional IRA in 2017 is $5,500 per person
- The limit is indexed for inflation each year after that
- If you are 50 or older, you’re allowed to make additional contributions (catch-up) above the federal limit to a maximum of $6,500
If you are an individual and head-of-household with a company-sponsored retirement plan, Traditional IRA contributions are tax-deductible, but only if your modified adjusted gross income (AGI) is lower than $62,000 to $72,000.
Your income phase-out range is $99,000 to $119,000 for married people if a contributing partner is enrolled in an employer pension plan. You may still invest in a Traditional IRA. The issue is you can’t deduct the investment from your annual income for income tax purposes.
The Roth IRA Explained
The Roth IRA is considered to be an innovation of the Taxpayer Relief Act of 1997. With this form of retirement program, your money is invested after taxes have been deducted. This means you’ve already paid taxes on the money you pay in and do not receive a tax deduction for your Roth IRA contributions. Then again, your funds in the account grow tax-free, and then when you become 59.5 years old, you can start making withdrawals without having to pay a penalty.
The key aspects of the Roth IRA are:
- The distributions are tax-free since the contributions were already taxed
- The investment income that your account has earned is an also free from taxation
- The Roth IRA contribution limits are the same as the traditional IRA
- There are contribution limitations so check with the IRS for current information
In the 2017 tax year, single individuals and heads-of-household with an AGI of $118,000 to $133,000 can contribute to a Roth IRA. For married couples filing jointly, the contributions are permitted at an AGI range of $186,000 to $196,000. It’s important to not that these income limits typically change from year to year.
The SIMPLE IRA Explained
A SIMPLE IRA stands for “Savings Incentive Match Plan for Employees.” This IRA is another type of choice for the numerous small business owners. This strategy makes it possible for an employer to match up to 3% of an employee’s contributions. For the 2017 tax year, the participation limit is $12,500 per individual. For men and women aged 50 and older, “catch-up” investment limits are $3,000.
Other SIMPLE IRA features include:
- The SIMPLE IRA is an attractive alternative to the 401(k) for employees of a small business and the self-employed.
- Deposits to the SIMPLE IRA are tax-deductible
- Small business owners are allowed to act as an employee and an employer which means they can contribute the maximum contribution plus the 3% employer match.
The SEP-IRA Explained
The SEP-IRA represents the “Simplified Employee Pension Individual Retirement Account.” The SEP-IRA rules are more complicated than the rules that are in place for the traditional or Roth IRA. Typically these this type of IRA is used by self-employed business owners who have only a few employees or no employees.
The SEP-IRA has the very same standard features as a traditional IRA. Although, the SEP-IRA has higher} contribution limits. The contributions deposited to the employee’s SEP-IRA cannot surpass the lower of 25% of compensation, or $54,000 for the 2017 tax year Account funds cannot be withdrawn until you are age 59.5, and account withdrawals must start by the age 70.
You Can have Multiple IRAs
Individuals are allowed to have more than one IRA in order to maximize their tax benefits. You must, however, keep in mind that for traditional and Roth IRAs, the contribution limits are combined. This means you can contribute a total of $5,500 to any combination of the IRAs.
However, you are allowed to a SEP-IRA or SIMPLE IRA in addition to your traditional or Roth IRA. To determine your maximum allowed contribution, consult a qualified financial professional.