Individual Retirement Accounts – The Four IRA Types
Individual retirement accounts, or IRAs, refer to an assortment of retirement plans in the United States. As a blanket term, the IRA may refer to traditional IRAs, Roth IRAs, SEP IRAs, or SIMPLE IRAs. The traditional IRA is the most basic account. This is a tax-deferred savings account in which taxes are only paid upon making withdrawals during retirement. All of the interest, capital gains, and dividends are compounded annually without being subjected to taxes, which means that your individual retirement account will grow much faster than any type of taxable account. They come in two forms: nondeductible and deductible, the latter of which is arguably the better deal because all IRA contributions are tax-deductible, meaning that you get a tax refund.
Roth IRAs are great because they allow all money in the account to grow and compound free from taxation. The Roth is funded with after-tax money, so you already pay the taxes on the funds up front before putting it into the retirement account. Paying taxes now with the Roth IRA means that you won’t pay taxes in retirement when you go to withdraw the funds. The Roth also comes with more built-in flexibility than traditional IRAs because you can withdraw contributions without penalty for qualifying reasons, or once you reach the age of 59 and a half.
SEP IRAs are for small business owners or self-employed individuals who want a type of traditional IRA. All contributions to the IRA are tax-deductible and the money will not be taxed until retirement, just like a traditional IRA. SEP IRAs also come with a higher contribution limit than traditional or Roth IRAs. This means that individuals can contribute as much as 25% of their income up to $49,000 a year.
SIMPLE IRA stands for Savings Incentive Match Plan for Employees and is also a traditional type of IRA specifically for small business owners and the self-employed. Like traditional IRAs, contributions are tax-deductible and will grow tax deferred until retirement. Whereas the SEP IRA doesn’t allow employees to make contributions, the SIMPLE IRA does. A SIMPLE IRA requires employers to make contributions on the behalf of the employees, essentially becoming an employer-matched retirement fund. It’s also cheaper to run than traditional, Roth, or SEP IRAs and is great for small business owners who want to bring in highly-qualified employees by offering attractive retirement benefits. Research all IRA employment and income restrictions carefully to see which IRA works best for you.