An Individual Retirement Account (IRA) can be a great way to save toward your retirement and take advantage of tax benefits. But did you know that there are a number of different types of IRAs that you can contribute to, each with varying options, requirements, eligibility and benefits?
There’s no one-size-fits-all approach to retirement, so these IRA options are designed for people with different kinds of financial and employment circumstances. The IRA menu has something for just about every investor, from the corporate executive to the small business owner.
With more than 100 years of combined experience helping busy people organize their financial lives, the team at PAX Financial Group has seen a lot of confusion when it comes to these different plans. To help you decide which might be right for you, our financial advisors in San Antonio, Texas worked together to weigh-in on 5 of the most common and popular IRAs, addressing potential pros and cons of each. If you have a question that is not addressed here or would like to discuss your specific situation in more detail, schedule a no-obligation conversation with our team. We’re here to help!
Planning for the future doesn’t have to be overwhelming. Schedule a no-obligation conversation with the team at PAX Financial Group today.
Traditional IRA
What is it? – The Traditional IRA offers multiple advantages. First off, contributions qualify for a tax-deduction in the year you make them, depending on your Modified Adjusted Gross Income (MAGI). Account earnings are not subject to taxes until you make a withdrawal, and withdrawals are taxed at the rate of whatever tax bracket you’re in when you take money out.
The benefits – If you’re in a lower tax bracket during retirement than you were in your working years, you can benefit from making contributions with pre-tax dollars, then paying tax when you make withdrawals (at a potentially lower tax rate).
The drawbacks – The annual contribution limit for 2021 is only $6,000 (plus an extra $1,000 for people 50 and older).
Roth IRA
What is it? – The Roth IRA is similar to the Traditional IRA in many ways, but has some key differences, primarily when it comes to taxes. Contributions to a Roth IRA don’t get the same up-front tax break, but distributions aren’t taxed later on in retirement.
The benefits – Withdrawals from a Roth IRA are tax-free, and you can take contribution money out at any time, without tax and penalties. (If you withdraw earnings, on the other hand, you may have to pay tax and penalties if you take money out before retirement.) If you expect to be in a higher tax bracket in retirement, a Roth IRA could make better sense, since you’ll contribute after-tax dollars when you’re working, but pay zero taxes on distributions (including earnings) in retirement.
The drawbacks – Just like with the Traditional IRA, a Roth IRA has contribution limits of $6,000 (plus a $1,000 catch-up allowance). Also, there are some eligibility requirements, based on income. Because of these restrictions, many people decide to do a Roth conversion, which allows you to bypass these restrictions. While this can be a very helpful strategy, there are some important aspects to consider first! Read our recent blog post: 5 Considerations Before You Convert Your IRA to a Roth IRA.
SEP IRA
What is it? – A Simplified Employee Pension (SEP) IRA is similar to a Traditional IRA, but for small business owners who want to offer their employees a retirement plan without the hassle and costs of administering a typical retirement plan. A SEP IRA allows employers to contribute on behalf of employees, which gives the employer tax advantages.
The benefits – The contribution limits for 2021 are higher than other IRAs or 401(k) accounts: Up to 25 percent of the employee’s compensation or $58,000, whichever is lower. Earnings grow in the account without tax; withdrawals in retirement are taxed.
The drawbacks – A SEP IRA doesn’t allow for catch-up contributions, and only a business owner or sole proprietor is eligible to set up this type of plan. Employers must also contribute an equal percentage of salary to all employees’ SEP IRAs, including their own.
Retirement planning for business owners can be especially complicated. If you are a small business owner, take advantage of these free resources:
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SIMPLE IRA
What is it? – The SIMPLE (Savings Incentive Match Plan for Employees) IRA offers benefits that are similar to an employer-sponsored 401(k) plan, while the tax rules are more inline with those for a Traditional IRA. The SIMPLE IRA is designed for small companies and the self-employed. Employers can contribute up to a 3 percent matching amount of employee contributions, or a fixed contribution of 2 percent of the employee’s compensation.
The benefits – Unlike a SEP IRA, a SIMPLE IRA allows employees to contribute a portion of their paycheck. Also, a SIMPLE IRA lets you roll money from the account to a Traditional IRA after two years.
The drawbacks – The annual contribution limits in 2021 are $13,500, plus a $3,000 catch-up contribution allowance for anyone 50 or older, which is lower than the annual limit for a Traditional 401(k), which is $19,500 plus $6,500 in catch-up contributions. Additionally, you may be subject to hefty penalties on early withdrawals within the first two years.
Self-Directed IRA
What is it? – A self-directed IRA is a variation on either a Traditional IRA or a Roth IRA, with one major difference: While Traditional/Roth IRAs typically involve investment in things like stocks, bonds, ETFs and mutual funds, a self-directed IRA allows you to invest in alternative types of assets like real estate, gold and silver, and privately held companies. A self-directed IRA is administered by a custodian or trustee, but managed directly by the accountholder – hence the name “self-directed.”
The benefits – Because of the broad range of assets that can be included, a self-directed IRA gives you more control and ability to diversify than the typical Traditional or Roth IRA.
The drawbacks – A self-directed IRA is not an account for the novice investor. There are very specific guidelines and requirements that must be followed, or you can wind up facing unexpected penalties and taxes. This type of account also tends to have a complicated fee structure.
Which IRA is Right for You?
Still not sure where to start or which type of IRA is the best fit for you? Wondering how to keep inline with the rules?
Don’t guess when it comes to your retirement! Talk to the financial advisors in San Antonio, Texas at PAX Financial Group. A financial advisor can help you determine if an IRA would work in your financial case, and if so, which type you may want to consider.
Retirement can be confusing
This material is provided by PAX Financial Group, LLC. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The information herein has been derived from sources believed to be accurate. Please note: Investing involves risk, and past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All market indices discussed are unmanaged and are not illustrative of any particular investment. Indices do not incur management fees, costs and expenses, and cannot be invested into directly. All economic and performance data is historical and not indicative of future results.
