Individual Retirement Accounts (IRA)
What is an IRA? Who needs one? What are the differences between the different types of IRA accounts? How do I know which IRA is right for me? These are the questions our clients come to us with on a daily basis and the issues we help sort out for them and their businesses.
An IRA is an individual retirement account. It is a type of account that almost anyone can open and fund on an annual basis (subject to annual limits), as long as they have earned wages from working during the year. There are some limitations and exceptions that apply to these accounts that can make them a little more complicated to navigate, but for the most part, they are a simple way for investors to start saving for retirement.
Traditional IRA
A Traditional IRA is one of the oldest types of IRA accounts and has been around since 1974. This type of account offers a tax deduction in the year that contributions are made and tax deferred growth of investments until the time distributions are taken from the account. This means you save on tax now, but will pay tax on more money in retirement.
There are restrictions on tax deductibility of contributions into IRA accounts for those who have access (or whose spouse has access) to an employer sponsored 401k plan or if the household income passes a certain threshold, however, with a long term plan and active retirement planning, investors of every income level can benefit from having a traditional IRA.
Roth IRA
The Roth IRA first came about in 1997, and in a lot of ways, it is the opposite of the Traditional IRA. Savers contribute to a Roth IRA with after tax dollars (meaning there is no tax deduction for contributions into a Roth IRA) but the Roth IRA grows tax free, and distributions taken from the Roth IRA are not taxable in the year of distribution. As with a traditional IRA, there are limitations and restrictions on who is eligible to contribute to a Roth IRA, but with a strategic retirement plan and active involvement from an experienced financial planner like ACap, every investor, including those with higher incomes, will find the Roth IRA a welcomed savings and investment account to add to their portfolio.
SEP IRA
A Simplified Employee Pension (SEP) IRA is a retirement account for self-employed individuals or business owners who want to save for themselves and on behalf of their employees. The SEP IRA has higher annual limits than a traditional or Roth IRA, and annual contributions limits are based on the annual net profits of the business. Contributions to SEP IRAs can only be made by the employer/business owner and can only be made with pretax dollars.
The SEP IRA is more complicated than either the Traditional or Roth IRA accounts and business owners often make funding mistakes that can be very costly to resolve, both in IRS penalties and past contributions owed to employees. For those with SEP IRAs, we work to maximize benefits to the employer/business owner and strategize ways to reduce taxes while growing the client’s retirement accounts. This may mean exploring other types of retirement accounts that may be more beneficial to the business owner or using the SEP IRA in conjunction with other retirement accounts.
SIMPLE IRA
The SIMPLE IRA is the IRS’s answer to easing the compliance burden that a traditional 401k plan creates, while allowing employers and employees to save for retirement on a pretax basis. SIMPLE stands for Savings Incentive Match PLan for Employees, and is named such because it offers very little flexibility to the business owner in exchange for the reduced compliance burden; it is “Simple” to administer because there are very few changes that can be made to the plan once offered by business owners to employees.
At its core, a SIMPLE IRA allows employers to save up to a maximum amount each year, while also allowing employees to participate up to the same amount, and incentivizing them to do so with matching employer/business owner funds. The simplicity comes in because the employer/business owner can save for themselves regardless of whether or not employees participate, as long as certain criteria are met.
With all of the different types of IRA accounts, it is important to strategize with an advisor to find the best fit for your overall financial plan and budget. All types of IRA accounts offer something unique, but what is offered may or may not be appropriate for you, depending on your unique circumstances.
