Using an IRA to save for retirement? You’re not alone. IRAs, also known as individual retirement accounts, are among the most popular retirement savings vehicles. According to a 2013 study from the Employee Benefit Research Institute, Americans own a collective 25 million individual retirement accounts. Those IRAs hold nearly $2.5 trillion in assets.1
There are many different types of IRAs, and each type addresses a unique set of needs and goals. If you don’t currently own 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 an overview of three of the most commonly used types of IRAs. Consider your own objectives before moving forward. Consistent, regular contributions to an IRA could be the strategy that helps you meet your retirement savings goals.
Introduced in 1974, the traditional IRA is the most commonly held type of IRA. Its popularity is largely due to its unique tax treatment. You may be able to deduct your contributions to your traditional IRA, 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 taxable as ordinary 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 has grown in popularity in recent years, largely because it can be used to generate tax-free income in retirement. Unlike the traditional, the Roth doesn’t offer deductions for upfront contributions. Instead, distributions from the account are tax-free. The Roth is similar to the traditional in the sense that growth isn’t taxed as long as the funds stay in the account.
The Roth also offers flexibility with 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. Keep in mind, however, 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 designed specifically for small-business owners. Its high contribution limits allow business owners to 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 tax-deductible contributions on their behalf. In some instances, the owner may be required to make contributions to employee accounts.
Ready to develop your IRA savings strategy? Let’s talk about it. Contact us today at Trinity Financial. We can help you analyze your needs and develop a strategy. Let’s connect soon and start the conversation.
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