Do you use an individual retirement account to save for retirement? If so, you’re not alone. Americans own a collective 25 million individual retirement accounts, also known as IRAs. According to a 2013 study from the Employee Benefit Research Institute, those IRAs hold nearly $2.5 trillion in assets, making the IRA one of the most popular retirement savings vehicles available.1
There are actually several different types of IRAs available, and each kind offers its own set of unique advantages. It’s not always easy to tell which kind is right for you. If you don’t currently have an IRA, you may be wondering which type is right for you. Even if you do own an IRA, you may be curious as to whether you should use a different type.
Below is information on three of the most commonly used types of IRAs. Consider your own needs and goals before you choose the IRA that’s right for you. Consistent, regular contributions to an IRA could be the strategy that helps you meet your retirement savings goals.
The original version of the IRA, the traditional, was introduced in 1974. The traditional IRA’s unique tax treatment is one of the reasons for its popularity. With a traditional IRA, you can take advantage of potential tax benefits today and in the future.
You may be able to deduct your traditional IRA contributions from your current-year tax return. The amount you are able to deduct depends on your income. You can then allocate your contributions across a wide range of investments based on your goals and risk tolerance. You don’t pay any taxes on investment growth as long as the funds stay in the IRA. This tax-deferred treatment could help your funds accumulate faster than they would in a taxable account.
All distributions from a traditional IRA are taxed as income. Also, you could pay a 10 percent early distribution penalty if you take a withdrawal before age 59½. While a traditional IRA offers upfront tax advantages, it creates taxable income in retirement.
The Roth IRA is a newer variation that shares some similarities with the traditional IRA, but it also has some important distinctions. Like the traditional IRA, the Roth comes with no taxes on investment growth as long as the funds stay in the account.
The major difference between the Roth and the traditional is in how contributions and distributions are treated. Unlike the traditional IRA, contributions to a Roth are made with after-tax dollars. That means you cannot deduct your Roth IRA contributions.
On the back end, though, you can take withdrawals from your Roth on a tax-free basis, assuming you are over age 59½ and the Roth has been open at least five years. That means you can use a Roth to generate tax-free income in retirement.
The Roth also offers flexibility with regard to when you can take distributions. You can always withdraw your contributions from a Roth without facing taxes or penalties, even if you’re younger than 59½. Also, you aren’t forced to take required minimum distributions from a Roth at age 70½, as you are with a traditional IRA.
Using a Roth can be an effective strategy for creating tax-free income in retirement. However, keep in mind that Roth IRA contributions are capped above certain income levels. If you’re a high earner, you may not be able to use a Roth.
The SEP IRA is a variation that’s designed specifically for small-business owners. It has very high contribution limits, which allow you to save a large portion of your income. From a tax standpoint, the SEP and the traditional IRA are treated similarly. Contributions to a SEP are deductible, while distributions are taxable. Growth is tax-deferred as long as the funds stay in the account.
The business’s employees are not allowed to contribute to the SEP, but the business owner can make contributions on their behalf. Those contributions are also deductible.
Ready to develop your IRA savings strategy? Let’s talk about it. Contact us today at Carstens Financial Group. We can help you analyze your needs and develop a strategy. Let’s connect soon and start the conversation.
Licensed Insurance Professional. This information is designed to provide a general overview with regard to the subject matter covered and is not state specific. The authors, publisher and host are not providing legal, accounting or specific advice for your situation. By providing your information, you give consent to be contacted about the possible sale of an insurance or annuity product. This information has been provided by a Licensed Insurance Professional and does not necessarily represent the views of the presenting insurance professional. The statements and opinions expressed are those of the author and are subject to change at any time. All information is believed to be from reliable sources; however, presenting insurance professional makes no representation as to its completeness or accuracy. This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice.
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