Retirement planning is crucial for securing your financial future, and utilizing retirement accounts like IRAs can play a significant role in achieving that. Jeremy Finger, a certified financial planner and founder of Riverbend Wealth Management, emphasizes the tax advantages of IRAs, which make them more appealing than taxable accounts. Traditional IRAs offer upfront tax deductions, while Roth IRAs provide tax-free growth.
To make the most suitable choice for your needs and goals, it is essential to comprehend the intricacies of IRAs thoroughly. By selecting the right retirement account, you can ensure a well-prepared and comfortable retirement, enabling you to enjoy your golden years to the fullest.
What is an IRA?
An individual retirement account, also known as an IRA, is a popular choice for saving money for retirement. According to Craig Reid, president and retirement advisor at Marsh McLennan Agency, IRAs offer a diverse range of investment options with significant tax benefits, making them an attractive option for long-term growth.
While Roth and traditional IRAs are commonly considered, it’s essential not to overlook other IRA options that might provide even more favorable tax and investment benefits. Spousal IRAs, Simplified Employee Pension Plans, Savings Incentive Match Plans, and various other IRAs can be viable alternatives worth exploring.
Selecting the most suitable IRA requires thorough research, as the right account will depend on factors such as your income, employment status, and whether your employer provides a retirement plan. Therefore, it’s crucial to evaluate your individual circumstances before making a decision.
Types of IRAs
Traditional IRA
The traditional IRA is a popular choice for individuals seeking control over their retirement savings. It offers various investment parameters, including a 2023 contribution limit of $6,500 and $7,500 for those aged 50 or older. One of the advantages is that account earnings are tax-free. Additionally, contributions may be tax-deductible, depending on your filing status and whether you have a retirement plan at work.
If you are eligible, you can deduct up to your contribution limit, which can be found on IRS.gov. However, withdrawing money before the age of 59½ might lead to a 10% tax penalty fee, with a few exceptions for hardships such as health insurance premiums during unemployment.
Roth IRA
Roth IRA Unlike traditional IRAs, a Roth IRA is funded with after-tax dollars, and qualified withdrawals are tax-free. It has a 2023 contribution limit of $6,500, and those aged 50 or older can contribute up to $7,500. While contributions are not tax-deductible, the advantage is that withdrawals in retirement are tax-free.
One of the benefits of a Roth IRA is its flexibility regarding early withdrawals. Contributions can be withdrawn at any time without penalties. Once you’ve held the account for at least five years and are over 59½, you can withdraw earnings penalty-free, but early withdrawals on earnings may be subject to fees.
SEP IRA
SEP IRA A Simplified Employee Pension (SEP) IRA is an excellent option for employers to save for retirement, both for themselves and their employees. It comes with minimal startup and operational costs. Employees must meet specific requirements to be eligible, including being 21 years or older, having worked for the company for at least three of the last five years, and receiving at least $750 in 2023.
Employers can contribute to the SEP IRA based on a percentage of earnings or a limit of $66,000 in 2023, whichever is smaller. One of the advantages of a SEP IRA is that there is no vesting, meaning employer contributions become completely owned by the employees. However, employees cannot contribute directly to their SEP IRA accounts.
Simple IRA
Simple IRA The Savings Incentive Match Plan for Employees (SIMPLE) IRA is a retirement savings option for small businesses with 100 or fewer employees. Both employees and employers can contribute to a traditional IRA. The employer may match up to 3% of the employee’s compensation if the employee elects to contribute and must contribute 2% of the employee’s compensation, even if the employee chooses not to contribute.
The 2023 contribution limit is $15,500, and individuals aged 50 or older can make an additional catch-up contribution of $3,500. Employers have the flexibility to choose between nonelective or matching contributions each year.
Nondeductible IRA
Nondeductible IRA If you or your spouse have a retirement plan at work and your income exceeds the IRA income limits, you won’t be able to deduct the excess amount contributed to a traditional IRA. However, this doesn’t prevent you from contributing to the IRA. While you won’t get a tax advantage on these contributions, they will still grow tax-deferred.
Properly reporting your nondeductible contributions on Form 8606 can save you money in the long run. By documenting that a portion of your IRA money has already been taxed, you ensure that when you make withdrawals, a portion will be tax-free, avoiding double taxation.
Spousal IRA
Spousal IRA For married taxpayers, there’s a way around the earned income requirement for contributing to an IRA. Even if one spouse has little or no income, the couple can contribute to separate IRAs (either Roth or traditional). The contribution limits for a spousal IRA are the same as for traditional and Roth IRAs, with a 2023 limit of $6,500 and $7,500 for those aged 50 or older.
Both spouses must file a joint tax return, and the spousal IRA can be funded by either spouse. However, the account must be opened under the name of the nonworking spouse.
Self-directed IRA
Self-directed IRAs come in two varieties: traditional and Roth. Both types adhere to the same eligibility and contribution guidelines as their counterparts. However, there is a significant difference when it comes to the types of assets you can hold within the account.
Unlike regular IRAs, which typically limit investments to conventional options like stocks, bonds, and mutual funds, a self-directed IRA offers more flexibility. It allows you to own assets such as real estate, gold, and shares in privately-held companies.
Setting up a self-directed IRA requires finding a trustee or custodian experienced in handling these less traditional investments. Keep in mind that certain transactions are prohibited within a self-directed IRA. For instance, borrowing money from the account or using it as security for a loan are actions considered equivalent to taking a distribution, which can lead to taxes and penalties on the entire account.
| OVERVIEW OF DIFFERENT IRAS | |||||||
|---|---|---|---|---|---|---|---|
| Traditional IRA | Roth IRA | SEP IRA | SIMPLE IRA | Nondeductible IRA | Spousal IRA | Self-directed IRA | |
| Contribution limits 2023 | $6,500 $7,500 (50 or older | $6,500 $7,500 (50 or older | The smaller of 25% of employee earnings or $66,000 | $15,500 $3,500 extra for 50 or older | $6,500 $7,500 (50 or older | $6,500 per spouse/ $7,500 per spouse (50 or older) | $6,500 $7,500 (50 or older |
| Tax-deductible contributions? | Yes | No | Yes | No | No | Traditional – Yes Roth – No | Traditional – Yes Roth – No |
| Tax-free withdrawals? | No | Yes | No | No | No | Traditional – No Roth – Yes | Traditional – No Roth – Yes |
The IRA lowdown
Taking control of your retirement is a significant step, and individual retirement accounts (IRAs) can be your key to achieving financial security. Unlike 401(k)s, IRAs offer you complete control over your investments without the need for an employer sponsor.
However, selecting the right IRA requires careful consideration of the various options available. Each type of IRA comes with its unique features and benefits. Understanding these differences is crucial in choosing the one that aligns best with your financial goals and retirement plans.
It’s essential to remember that IRAs are designed to be long-term retirement savings tools. Withdrawing funds prematurely may lead to missed opportunities for substantial growth over time. Patience and commitment are essential in maximizing the potential benefits of your IRA.
