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Types of IRA and Their Tax Benefits

IRA > Long Financial Services

IRA – There are a number of Individual Retirement Accounts (IRAs). Each offers its own tax benefits. Here’s a quick summary of what you need to know.

1. Traditional IRA

The traditional IRA has a number of notable features.

* The annual tax-deductible contributions are based on income level.

* The contributions are paid with pre-tax dollars, thus reducing your taxes owed at each pay cycle.

* Some employers offer a match, or a match up to a certain percentage. This is like tax-free “found money” and can really start to add up over time.

* Taxes are paid on earnings when they are withdrawn from the IRA. Withdrawals can begin at age 59.5 and are mandatory by age 70.5.

* Anyone under the age of 70.5 who is earning income can contribute to an IRA, up to the maximum annual limit. The annual limit varies from year to year and depending on the age of the person contributing. Older people are allowed a higher percentage of contribution to “top up” their IRA.

* Funds withdrawn from an IRA before age 59.5 are subject to taxes and a 10% penalty unless the person has an exception. Exceptions include buying a home for the first time, high medical expenses, or disability.

* A traditional IRA can be converted to a Roth IRA if you pay income tax on the IRA distribution before rolling it over to a Roth IRA. There will be no tax penalties for taking the distribution in this case.

2. A Roth IRA

* With a Roth IRA, the contributions are not tax deductible, but this can depend on income level.

* There is no mandatory distribution at age 70.5, so you can keep your money in longer.

* All the earnings and principal in a Roth are 100% tax free provided that you follow all the IRS rules and regulations. Keep up to date at their website: https://www.irs.gov/retirement-plans/roth-iras

* There are contribution limits annually, as detailed here:
https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits

* Principal can be withdrawn at any time without a penalty provided it has been in the account for at least five years.

* No tax is paid on the distributions you take out.

3. A SEP IRA

A Simplified Employee Plan (SEP) IRA is a retirement plan set up by an employer on behalf of their employees. They can make tax-deductible contributions, which will go into a traditional IRA. Employers choose how much they want to contribute to a SEP each year, with certain dollar and percentage limits. The percentage must be the same for each employee every year.

A SEP is ideal for any self-employed person or small business owner. SEPs can be opened by any type of business entity, including a sole proprietorship, a corporation or a partnership with up to 100 employees. In the case of sole proprietorships, the business owner is considered the employee for plan purposes.

There are certain age and work history restrictions. The employer gets to decide if they will make a contribution or not, which is ideal if a businessís income is unpredictable. All contributions are tax-deductible.

4. A SIMPLE IRA

SIMPLE stands for Savings Incentive Match Plan for Employees. This is similar to a SEP, except that employees can make tax-deductible contributions and receive matching contributions from their employer. There is a maximum annual limit to the contributions, as there would be with a traditional IRA.

 

If you need help with deciding on which kind of IRA you should have or any other retirement vehicles, give us a call or drop us an email.

Long Financial Services

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