Individual Retirement Accounts (IRAs) are self-directed individual retirement plans that offer certain tax advantages.
Many financial institutions offer these plans, and IRA owners can invest in any type of investment that the custodian allows, ranging from simple Certificates of Deposit (CDs) to individual stocks and bonds.
Types of IRAs
Two types of IRAs, Traditional and Roth IRAs, allow employees to control and make contributions to on their own, while the third type of IRA, the SEP IRA, is distinct in being an employer-provided benefit. Below is an overview of each of these three types.
If you don't know which is best for you, check out this guide: The Ultimate Guide To Roth vs Traditional IRA Contributions.
Traditional IRAs are tax-deductible (as long as the owner's income does not exceed certain limits) and tax-deferred retirement accounts, meaning that annual contributions to the IRA are not taxed at the time of contribution and are instead taxed when money is withdrawn.
This may be a good choice for investors who expect to be at a lower income tax bracket in the future (or investors who believe future tax brackets will be lower in general, even if they believe they will be making the same amount of money).
Roth IRAs are post-tax retirement accounts, meaning that money contributed to the account has already been taxed.
However, both the amount contributed and future earnings on the investments in the account may be withdrawn without paying further taxes. This may be an advantageous choice for investors who believe they will be in a higher tax bracket in the future.
Simplified Employee Pension (SEP) IRAs are used by business owners and must also be offered to all qualifying employees, if there are any.
Employees that are at least 21, who have worked for that employer for three or more years out of the previous five, and who have earned at least $600 (the limit for both 2017 and 2018) for that year qualify to participate in the plan.
Only employers may contribute to a SEP IRA, though they are not locked into making certain annual contributions the same way a 401(k) plan might be.
Withdrawals from IRAs
IRAs, because they are designed to provide for people during their retirement years, impose restrictions on withdrawing funds before retirement age, which is defined as age 59½ or complete and total disability.
If the withdrawal does not meet the requirements for a qualifying exception to these provisions, a 10% penalty will apply to the amount withdrawn.
2018 Contribution Limits for IRAs
Under Age 50
Up to 25% of income or $55,000
Age 50+ Catch Up Contribution
2018 IRA Income Limits
Married, Filing Jointly
Phase out starting at $189,000 - $199,000
Married, Filing Separately
Phase out starting at $0 - $10,000
Phase out starting at $120,000 - $135,000
Anyone with earned income and younger than 70 1/2 can contribute to a traditional IRA, but tax deductibility is based on income limits and participation in an employer plan.
Using either a Traditional or Roth IRA (whichever makes most sense in your tax situation) is an excellent tool in addition to any retirement plan your employer offers, including 401(k) plans and SEP-IRAs.
Individuals should attempt to make the maximum contribution allowed to their Traditional and/or Roth IRAs annually to take full advantage of the tax savings available.
Do you have an IRA? What will you do to try to max out retirement contributions in 2018?