An individual retirement account is an investing tool used by individuals to earn and earmark funds for retirement savings. Individual Retirement Accounts are provided by many financial institutions and they provide tax advantages for retirement savings in the United States. Sometimes referred to as individual retirement arrangements, IRAs can consist of a range of financial products. These products include stocks, bonds, and mutual funds, to name a few. What are the types of Individual Retirement Accounts? Which one is perfect for you? Here, we find out:
Types of IRAs
- Traditional Individual Retirement Accounts
- Roth Individual Retirement Accounts
- SIMPLE Individual Retirement Accounts
- SEP Individual Retirement Accounts
A traditional IRA is a way to save for retirement that gives you tax advantages. In most cases, contributions to traditional Individual Retirement Accounts are tax deductible. The deducted amount, whether fully or partially, will depend on certain circumstances though. However, if you withdraw from the account during retirement, your withdrawals will be taxed as income.
Roth Individual Retirement Accounts
The Roth IRA name originated from Senator William Roth Junior. Roth IRAs were introduced as part of the Taxpayer Relief Act of 1997. Contributions under this type of IRA are not tax-deductible. However, eligible distributions are tax-free which means that you contribute to a Roth IRA with after-tax dollars. In addition, as soon as the account grows, you do not face any taxes on capital gains. Also, when you retire, you can withdraw from the account without incurring any income taxes on your withdrawals.
SIMPLE stands for Savings Inventive Match Plans for Employees. This type of IRA is for small businesses and self-employed individuals. It allows employees to make contributions to their accounts while the employer is required to make contributions too. However, all the contributions are tax deductible. The plan is similar to a 401(k) plan, but with lower contribution limits and simpler administration.
SEP-IRA stands for Simplified Employee Pension Individual Retirement Arrangement. Self-employed individuals and small business owners can have SEP-IRA. If you’re a business owner, and you wish to set up a SEP-IRA for your employees, you can deduct the contributions from your reported business income. In turn, you can potentially secure a lower tax rate on business income. However, your employees cannot contribute to their accounts. In addition, their withdrawals during retirement will be taxed as income.
Required Minimum Distributions
Your required minimum distribution is the minimum amount you must withdraw from your account each year. However, note that you can withdraw more than the minimum required amount. Whenever you make a withdrawal, it will be included in your taxable income except for any part that was taxed before. Or, the withdrawal can be received tax-free in cases such as qualified distributions from designated Roth accounts.