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Understanding the Different Types of IRAs

by Bruce Haring

An individual retirement account or an IRA is a financial product for individuals that helps them to save for their retirement. In the US, a number of IRA plans are provided by various financial institutions and organizations. All such IRA plans help the individuals in earning interest income over their savings along with a myriad of tax benefits.

An IRA is also described as a form of ‘individual retirement arrangement’ that broadly contains a trust account set up for the benefit of the taxpayers and/or their beneficiaries along with an individual retirement annuity. The annuity contract is to provide a definite flow of future income, beginning after a certain period of time.

IRAs were first introduced in the US in 1974 under the Employee Retirement Income Security Act to help individuals save for their retirement because depending on social security is foolhardy for a variety of reasons. An individual can contribute up to 15% or $1,500 (whichever is less) of his or her annual income in IRA. The amount contributed towards an IRA is not taxed.

Let’s go through some of the various IRAs available in the US, along with their concise details.

  • Traditional IRAs

As the name suggests, this is a traditional form of IRA in which the contributions are deposited before the tax is deducted from them. This renders the withdrawals after retirement to be taxed as income (if the contributions were not tax deducted in the first place). However, all the transactions within the retirement account will have no tax implications. The deductible or non-deductible characteristics of the account will depend on the nature of contributions.

The traditional IRA basically helps you postpone your taxes to be paid at a later stage. When the deposits are made, the earnings on the deposits grow tax deferred. The earlier you start investing in a traditional IRA, the more time your savings will be able to compound and increase tax free.

There are certain considerations to be taken into account while dealing with traditional IRAs.

  1. Eligibility is not limited by income
  2. No contributions towards the account is allowed after the age of 70.5 years
  3. RMD or required minimum distribution are to start after the age of 70.5 years
  • Roth IRAs

A Roth IRA is another type of IRA that is popular in the US. It is named after the senator William V. Roth. The Roth IRA allows you to make contributions after taxes have been deducted from them. In other words, the contributions are in the form of after-tax assets. This will result in tax free withdrawals after retirement and no tax implications within the IRA. In a high tax environment which America is dealing with now, these are huge positives.

This may be termed as a stress free investment as you don’t have to worry about paying back taxes after your retirement and every dollar you withdraw attracts no tax. There are certain restrictions included with the Roth IRA, but the benefits eclipse them. An added advantage is that the Roth IRA, when passed on to your beneficiaries, still remains tax free.

The considerations to be taken into account while dealing with a Roth IRA are:

  1. There are no required minimum distributions or RMDs, no matter how long you live.
  2. There are no age limitations to when you can open a Roth IRA and for how long you can contribute to it.
  3. The eligibility to open a Roth IRA and amount of contributions is restricted by your current income level.

The SEP IRA is a variation of the traditional IRA, which is used by small businessmen and organizations for their employees. The employer can enter into a Simplified Employee Pension Individual retirement arrangement for all its employees in equality and also for himself. Since it is only a variation of other IRAs, the funds are invested in the same manner as any other IRA.

The employer may impose certain restrictions on the employees benefiting from the SEP IRAs such as:

  1. The employee has attained the age of 21
  2. Has worked for the employer in three of the five previous years
  3. Has received at-least $600 in compensation for the tax year (2015)

The restrictions may vary from employee to employee depending upon the organization. The contributions towards a SEP IRA is considered part of profit sharing plan. The employee can contribute up to 25% of the employee’s salary towards his/her SEP IRA account.

These are a few types of IRAs prevalent in America. You can easily choose one of these to have a peaceful and economically stable retirement if you invest wisely. If you invest in stocks and those companies fail in your IRA, you will lose money.

You do not invest in an IRA – not in and of itself, you invest in different avenues within an IRA. For 2016, you can invest up to $6,000 in an IRA. If you invest wisely and do this year after year, you could have a comfortable retirement.


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