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 isn’t just one type of IRA, though. In fact, there are many different types, and each kind offers its own set of unique advantages. 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 IRA, was introduced in 1974. It’s the most widely held type of the account.
The traditional IRA’s popularity is driven in large part by its tax treatment. Contributions to your traditional IRA may be deductible, depending on your income. Growth in the account is tax-deferred, which means you don’t pay taxes until you take a distribution.
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 has a slightly different tax treatment. Unlike the traditional, the Roth doesn’t offer deductions for upfront contributions. Instead, distributions from the account are tax-free. Like a traditional, growth in a Roth isn’t taxed as long as the funds stay in the account.
The Roth also offers flexibility with regard to 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.
A Roth can be an effective strategy for creating tax-free income in retirement. However, keep in mind that the 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, so business owners can save a large portion of their income. From a tax standpoint, it’s treated similar to a traditional IRA. Contributions are deductible, while distributions are taxable. Growth is not taxed 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 employee contributions are also deductible.
Ready to develop your IRA savings strategy? Let’s talk about it. Contact us today at Legacy Retirement Services. We can help you analyze your needs and develop a strategy. Let’s connect soon and start the conversation.
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Terry L. Tyler