IRA 101: A Primer
Just about everyone knows a little about IRAs. They’re a way to put money aside for retirement while generally receiving a tax deduction. Your contributions – as well as earnings and gains from these contributions – accumulate tax-free until you take money out of the account.
There are several kinds of IRA-based plans. Each investor must consider what is the best IRA Plan for their objectives. Here are the most widely known:
Traditional IRA: Still the most popular
Think of the traditional IRA as an individual savings plan. You make a tax deductible contribution each year of $5,000 if you’re under 50, and $6,000 if you’re 50 or above. Withdrawals can be made once you reach 59 ½, and you must begin withdrawing from your account once you reach the age of 70 ½.
Roth IRA: Fewer withdrawal restrictions
A Roth IRA works a little differently than a traditional IRA. Contributions are made with money that is already taxed, so there is no immediate tax break, but when Roth money is taken out, it’s tax- and penalty-free. If you’re in a lower tax bracket now, but expect to be in a higher tax bracket at retirement, the Roth IRA may be a good choice for you. Another advantage: you can keep your money in a Roth IRA to earn tax-free income even if you have already reached age 70 ½.
Traditional or Roth IRA – which is right for you?
| |
Traditional IRA |
Roth IRA |
Who can invest? |
Individuals under 70 ½ who earn compensation |
Individuals of any age with certain income limits |
Tax deductibility |
Yes – based on participation in your retirement plan and adjusted gross income. |
No |
Withdrawals |
Taxed upon withdrawal |
Free from federal tax |
Penalties for early withdrawals |
Yes – if you are under 59 ½ and are not withdrawing for an approved reason. |
Same – and you must have owned your Roth IRA for 5 years. |
Mandatory age at distribution |
70 ½ |
None |
SEP-IRA (Simplified Employee Pension): IRA for the self-employed
The SEP-IRA is, in effect, a traditional IRA set up by an employer for the firm’s employees. An employer may contribute up to 15% of an employee’s yearly compensation into each account.
Spousal IRA: Designed to help non-working spouses
Like the name implies, a spousal IRA is a traditional or a Roth IRA that’s funded by a husband or wife in the name of a spouse who earns less than $2,000 a year. The couple must file a joint IRA in the year of the contribution.
Rollover IRA: From one qualified retirement plan to another
The rollover IRA is a traditional IRA set up by an individual to receive a distribution from a qualified retirement plan. Distributions transferred to a rollover IRA are not subject to any contribution limits.
Inherited IRA: From any beneficiary other than your spouse
The inherited IRA can be either a traditional or Roth IRA from someone other than your husband or wife. A tax deduction is not allowed for contributions to this IRA and the proceeds must be distributed and taxed within a time period established by the Internal Revenue Code.