What is an IRA? It is short for an Individual Retirement Account that allows for you to create savings to support your retirement. The benefit of an IRA is that they are structured to provide large tax breaks for Americans to assist them (and encourage them) to put away money for the future. It is not a single investment, but rather a place where you put your bonds, mutual funds and stocks together to review and monitor the progress of your savings portfolio.
How does an IRA differ from a standard 401(k) account? An IRA is something you the individual set up whereas your 401(k) plan is established by your employer. An IRA can also be opened by a self-employed individual or owners of small businesses but not everyone gets to take advantage of them as a tax shelter. Each individual IRA has a number of rules, eligibility requirements and restrictions as well as limits as to how much can be contributed to the tax shelter. There are also a variety of penalties for withdrawing funds prematurely from an IRA account which are punitive.
The Individual Retirement Account (IRA) is a critical part of responsible financial planning. Not only do they help you pay less tax on your earnings by depositing funds into your IRA but it assists Americans to better prepare for their retirement. It is important to learn as much as you can about the mechanics of an IRA and the different types that are available. There are eleven (11) types of IRAs to consider and each one has a benefit and will assist you to diversify your income for protection from market adversity, as well as assisting to maintain your standard of living after retirement.
How Do They Work?
It is important to note that an IRA is not in itself an investment, but rather a place to build equity that will be invested for retirement. Contributing to your IRA allows you to have the assets required to purchase stock and other investments and build your portfolio from a variety of different investment opportunities. As you place money into your IRA for investment, that income is sheltered against income tax.
Contributions to an IRA are made on a pre-tax basis. For instance, if you made $50,000 annually and you decided to put 10% of your income into an IRA ($5,000) your taxable income for that reported year would be $45,000 after the $5,000 shelter of the established IRA. You can see why there are legislated limitations as too how much can be invested in an IRA as a shelter, however the taxable benefit exists to encourage Americans to budget and allocate as much as possible toward their retirement.
You save money now and taxes while building a more secure retirement in your future when you establish an Individual Retirement Account (IRA). But that is not the best part. The interest that grows on the money which is invested in an IRA is also protected from tax and continues to grow tax-deferred without capital gains from the interest. After the age of sixty-five (65) years when the money is withdrawn from the Individual Retirement Account the money is taxed at a regular rate (at a lower pre-tax income level).
So which IRA is best for you and your family when it comes to planning a quality retirement? We are going to list the eleven different types of IRAs and weigh some of the advantages and disadvantages of each in terms of opportunities as well as restrictions and eligibility requirements to help you find the best investment vehicle for your money.
How to Choose the Right One
There are more than a few different Individual Retirement Accounts to choose from and many feel that they don’t know where to start when assessing which one is best for their individual needs. Let’s start by taking a look at the different types of IRAs to choose from.
1. An Individual Retirement Account refers to the classic or Roth IRA structure provided by a major institution such as a federal bank, licensed broker or mutual fund. The contributions made may be applied to investments and securities such as stocks, money market accounts or bonds.
2. The Individual Retirement Annuity can be a traditional or also a Roth set up through a life insurance company and purchased through a specified contracted annuity.
3. A Group IRA is an employer or association trust account that can be set up by employers or unions or legal employee associations and members.
4. The SEP-IRA stands for a Simplified Employee Pension which is set up by the employer and in which the employer may contribute up to $30,000 or up to 15% of the salary of the employee annually.
5. When employees and employers match savings it is called a Savings Incentive Match Plan for Employees IRA (SIMPLE-IRA). The cap for employee contribution is levied each year and increases in $500 increments the longer the employee is in the plan. In 2013 the contribution limit for this type of IRA was $13,000.
6. Married spouses can participate in a special Spousal IRA which provides for a stay-at-home parent without income exceeding $2,000 annually. A couple can contribute up to $4,000 to this IRA allowing for a minimum of 50% investment in the IRA annually.
7. A Conduit IRA is sometimes referred to as a Rollover IRA. This traditional IRA is established by an individual to receive funds from a qualified retirement plan. There are a number of restrictions and eligibility requirements for this type of account.
8. Providing for the surviving family or children (not including the spouse) an Inherited IRA can fund other beneficiaries after death. The funds held in an Inherited IRA must be dispersed to the surviving beneficiary within a period of time defined by the Internal Revenue Code.
9. Planning for education is made easier by an EIRA (Education IRA) which allows for a contribution of up to $2,000 per year tax free. The benefit of the EIRA is that funds can be withdrawn without taxes or penalty as long as the amount is being withdrawn for payment of the child’s education costs.
10. For individuals under the age of 70.5 years who have earned income, a Traditional IRA allows savings to grow in a tax-deferred environment until withdrawal at which time; the income is taxed at a regular rate. Withdrawal from the account is required starting at the age of seventy years or a punitive 50% penalty is levied against any balance that is not withdrawn as per the annual withdraw requirements. Once the portfolio has reached $150,000 deductions and shelters for further contributions are lost.
11. The last type is a Roth-IRA which is an individual account that provides a future tax break. Imagine withdrawing your money after retirement and having that income be tax free? It is an impeccable tax shelter if you are at an income level where taxes are high and for those who anticipate their retirement earnings to be quite lower.
Make it a Combo
Many people choose to have more than one IRA and typically pair a Roth-IRA with another a second one to meet their retirement needs. If you have school aged children consider investing in a Roth and an EIRA which would allow you to meet the unexpected financial demands of your child and their education while providing tax free income after your retirement. If one of the parents of the household is unemployed or a stay-at-home parent then leverage the advantages of the Spousal IRA. There are many options to choose from and a qualified financial advisor can assist you to choose the right combination for your financial goals.
You work hard for your money. Seek out all the opportunities that are available to keep as much of that money out of the hands of the tax man and working hard for a quality retirement instead.
Joshua Geary is a financial writer and experienced blogger for the real estate IRA for Sunwest Trust, Inc. When he’s not writing about IRA investment options and the self-directed IRA rules and regulations that go along with them, Joshua enjoys reading and swimming in his leisure time.