IRA accounts are confusing and unfortunately, not many colleges or workplaces offer the education needed to understand them fully. As valuable as these accounts can be to saving for retirement, though, it is crucial to familiarize yourself with them and how they can benefit you.
1. THE TRADITIONAL IRA
A traditional IRA allows you to make tax-deductible contributions to your account annually. The limit on the amount of these contributions is determined by your income level and taxes are paid on the money when it is withdrawn from your account.
Funds can be withdrawn from the traditional IRA account once you hit age 59 Â½ but can be postponed until age 70 Â½. Funds CAN be withdrawn from the traditional IRA prior to the age of 59 Â½, however, with very few exceptions, these withdrawals will carry a 10% penalty.
Traditional IRA accounts can be transformed into Roth IRA accounts but only by paying taxes on the IRA account first.
2. THE ROTH IRA
Contributions to a Roth IRA account are not tax deductible and not everyone is eligible for a Roth IRA. Specific income levels determine the point at which you are eligible to have a Roth IRA account.
Funds can be withdrawn without penalty from the Roth IRA account at any point after they have been invested for five years and when the investor is 59 Â½ years old. Withdrawals from a Roth IRA account are tax-free if these criteria are met or if withdrawals made before 59 Â½ are up to the amount that has been contributed to the Roth IRA account. Funds withdrawn before age 59 Â½ and above your contributions will be taxed UNLESS you are experiencing certain financial hardships, you are paying for higher education, or you are purchasing a home.
3. The SEP IRA
A SEP IRA is also known as a simplified employment plan- or simply a SEP. SEP accounts must be set up by employers for their employees. Employers can make contributions to this fund that are tax deductible but these contributions are limited. Employer contributions to the SEP IRA can be up to 25% of an employee's annual income but dollar limitations do apply. These employer contributions must be the same percentage each year but employers can decide each year whether to make contributions to SEP IRA funds.
SEP IRA accounts can be set up for employees by any business with 100 employees or less. Employees are eligible for IRA accounts if they are aged 21 years or older, have worked for the employer for a specified amount of time, and makes more than a specific amount (referred to as an exclusion allowance-).
Withdrawals from a SEP IRA account are taxed as income at income tax rates when withdrawals are made after age 59 Â½.
4. THE SIMPLE IRA
The Savings Incentive Match Plan for Employees- or SIMPLE- IRA is an account set up by employers for their employees. Employers with 100 or fewer employees can set up these accounts. Contributions can be made to these accounts by employees and these contributions are matched by the employer.
There is a percentage of annual salary limit of employee contributions to the SIMPLE IRA account per year. Employers must match employee contributions to the SIMPLE IRA up to 3%. Employers also have the option to contribute 2% of compensation for each employee of the company instead of matching contributions.
Withdrawals from a SIMPLE IRA account must be considered qualified withdrawals-. Unqualified withdrawals from these accounts come with a 10% penalty. If unqualified withdrawals are made within two years of setting up the SIMPLE IRA account, the penalty is 25%! Qualified withdrawals include withdrawals made over the age of 59 Â½, withdrawals due to permanent disability, withdrawal by next of kin due to the individual's death, withdrawal used to pay for higher-education fees, withdrawal taken in equal payments over your remaining lifespan, withdrawals of $10,000 or less made to purchase a first home, withdrawal to pay premiums for health insurance when unemployed, withdrawals to pay for medical expenses that have not been reimbursed, or withdrawals made by a reservist who has been called to serve on active duty.
Additionally, all withdrawals from the SIMPLE IRA account are taxed as income at income tax rates.