While it is essential to save for retirement, sorting through the options for retirement accounts isn’t always easy. Individual retirement accounts come in many shapes and sizes. Choosing the right one will depend on factors such as your job, income level and household situation.
The types of IRAs include:
— Traditional IRA.
— Roth IRA.
— SEP IRA.
— SIMPLE IRA.
— Self-directed IRA.
— Spousal IRA.
— Inherited IRA.
— Rollover IRA.
— Custodial IRA.
With a traditional IRA, if you are under 50 years old, you’re allowed to contribute up to $6,000 in 2022 or 100% of compensation, whichever is less. For those who are 50 or older, up to $7,000 can be contributed.
“These plans are best for those who are not covered by a traditional employer retirement plan or who make less than $78,000 as a single taxpayer or $129,000 as married, filing jointly,” says Katharine Earhart, partner and co-founder of Fairlight Advisors in San Francisco.
Deductions are reduced and eventually phased out completely for people who have a 401(k) or similar type of retirement account at work and earn more than $68,000 as an individual and $109,000 as a married couple in 2022. Some of the main benefits of a traditional IRA include that contributions are tax deferred, which lowers your annual taxable income. The investments grow tax-free until you take withdrawals, at which time they are taxed as income. When you turn 59 1/2, you are eligible to start making withdrawals without facing any penalties.
Through this type of retirement plan you’re allowed to make contributions of up to $6,000 in 2022 or 100% of compensation, whichever is less, if you are not yet age 50. For those who are 50 and older, a contribution of up to $7,000 is permitted.
“The Roth has different phase-out ranges,” Earhart says. For single taxpayers, the phase out starts at $129,000 and ends at $144,000. For married filing jointly, it begins at $204,000 and phases out completely at $214,000. Unlike the traditional IRA, Roth IRA contributions cannot be deducted from your taxable income. The earnings grow tax-free, and when you take out qualified withdrawals, the amount will not be taxed.
“Depending on circumstances, this account might be best for someone in a lower tax bracket or an individual who has a long time horizon toward retirement,” Earhart says.
If you are self-employed or have a small business, you can set up a Simplified Employee Pension (SEP) IRA. Some of the eligibility requirements include being at least 21 years old, having at least three years of employment and earning at least $650 annually. Employers can contribute up to $61,000 or 25% of eligible income in 2022. Regarding taxes, a SEP IRA is similar to a traditional IRA in that it is a tax-deferred account.
“In a SEP, the employer is the only one who can make a company contribution to the IRA via payroll,” says Robert Massa, managing director of Qualified Plan Advisors in Houston. “The account is 100% vested, but is essentially discretionary and doesn’t have to be funded every year.”
A Savings Incentive Match Plan for Employees (SIMPLE) IRA is established by a small business for employees. In these plans, employees who are eligible can choose to defer income from their paycheck, which is similar to a 401(k) plan. The employer is required to make a contribution each year for all eligible employees. This employer contribution will be either a 2% nonelective contribution to all eligible employees regardless of their choice to participate in the plan, or a matching contribution of up to 3% of pay, which is only given to workers who participate and make contributions from their pay.
“They are much easier to administer than 401(k) plans, making them attractive to small employers,” Massa says. Employees can contribute up to $14,000 in 2022, and those age 50 and older can make catch-up contributions of up to $3,000.
Available as a traditional or Roth, a self-directed IRA allows you to manage your investments. You’ll need a custodian to administer the account and can then make investments that are usually not included in other types of IRAs. You might choose to invest in real estate, precious metals, limited partnerships, commodities and other alternative investments. There could be additional risks and costs to these accounts, so they are best for individuals who are savvy in their investment choices and want to direct funds on their own.
You usually need earned income in order to contribute to a retirement account. However, a spousal IRA is designed for a married couple that files their taxes jointly, but only one spouse has income. The spouse who does not have an income can make a contribution to the spousal IRA. “The deductibility of any contributions is still subject to the adjusted gross income limits,” Massa says.
An inherited IRA is opened when you are the beneficiary of another person’s retirement plan after that individual has passed away. The rules for how you will need to distribute the account’s assets will depend on your relationship to the deceased, your age and other eligibility requirements. Special rules apply for spouses, minor children, disabled beneficiaries and those who are not more than 10 years younger than the original account holder.
[See: 10 Steps to Max Out Your IRA]
A rollover IRA is designed to receive funds that come out of your previous employer’s workplace retirement plan, such as a 401(k) or 403(b). “These accounts can be either traditional or Roth,” says Melissa Walsh, founder and president of Clarity Financial Design in Sarasota, Florida.
These accounts can be traditional or Roth and are created for minors. “To qualify for these accounts, a child must have earned income,” Walsh says. The maximum that can be contributed to the account is $6,000 or the total earned income, whichever is less. Assets are managed by the custodian until the child reaches age 18, or 21 in some states.
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