An Individual Retirement Account (IRA) is a savings account that provides great tax benefits for money you’re saving for retirement. Knowing about the differences of each IRA type can help you make the best choice for the income you need after you stop working.
A Traditional IRA is a pre-tax retirement account. Depending on your situation, you may have pre-tax and after-tax money in your IRA. Contributions are often tax-deductible to an annual limit set by the IRS, if you meet certain requirements. You only pay taxes on your earnings and deductible contributions when you withdraw funds from the account. Because you don’t have to pay taxes on those funds as they grow, your balance can grow more than the funds in a taxable account.
A Roth IRA is funded with after-tax dollars. Because Roth contributions are never tax-deductible, they are never taxable upon withdrawal. Earnings are not taxed as long as the account has been open for five years and funds are not withdrawn before age 59½. Keep in mind a Roth IRA has income restrictions, which may limit your eligibility.
A Simplified Employee Pension (SEP) is an ideal IRA for self-employed individuals and small businesses, including nonprofit organizations and owners who want to offer retirement benefits without the requirements of more complex plans. Employers make tax-deductible contributions to an employee’s SEP IRA. Employees themselves do not make contributions. In most other ways, an SEP IRA account is like a Traditional IRA and follows the same investment, distribution and rollover rules as Traditional IRAs.
Am I eligible?
The IRS sets rules on whether you are eligible to contribute to each IRA and if you can take advantage of the tax benefits offered by each. Your age, income, tax filing status and whether you or your spouse have a retirement plan at work, like a 401(k) or 403(b), all factor in to the requirements. The IRS restrictions around Roth IRA eligibility and Traditional IRA eligibility differ. How and when you can contribute funds to each type is also unique.
An IRA is one easy way to get started building up or adding to retirement savings. Ask a financial professional for help deciding which option is best for you.
The advice provided is for informational purposes only. Contact a financial advisor for additional guidance.