IRA – Individual Retirement Accounts
Individual retirement accounts, or IRAs, are a method for saving money for retirement that is either tax-free or tax-sheltered. There are several types of IRAs, each with its own benefits, rules, and contribution limits. If you set up your IRA through a brokerage firm, you’re allowed to invest the funds in stocks, bonds, mutual funds, real estate and some other government-approved asset classes.
A traditional IRA allows you to deposit pre-tax earnings for distribution after you reach retirement age. You contribute funds and receive a tax deduction, and your money is sheltered from taxes until you withdraw it at retirement time. The thought process is that you won’t withdraw the funds until you stop working, so the distribution you receive from the IRA will be taxed at a lower rate. If you tap into your nest egg before you are 59 ½ years old, there is a 10% penalty on top of the other taxes due. You must begin taking out the cash at age 70.5. For the 2014 tax year, the traditional IRA contribution limit is $5,500 per person; thereafter it is indexed for inflation in $500 increments. If you are 50 or older, you can make additional “catch-up” contributions above the government limit to $6,500. For individuals and heads-of-household who have an employer-sponsored retirement plan, traditional IRA contributions are only tax-deductible if your modified adjusted gross income (AGI) less than $60,000 to $70,000; the income phase-out range is $98,000 to $116,000 for married couples when the partner contributing is covered by an employer pension plan. You can still contribute to a traditional IRA, you just can’t deduct the contribution from your income for tax purposes.
The Roth IRA was created by the Taxpayer Relief Act of 1997, and your funds are invested after taxes – which means you have already paid taxes on the money you deposit and do not get a tax deduction for Roth IRA contributions. However, the money in the account grown tax-free, and you can begin taking withdrawals without a penalty when you each the age of 59 ½. There is no tax on Roth IRA distributions; you already paid the tax on the income before you deposited it. The main benefit is that the interest or investment income the account has earned is also tax-free. Roth IRAs have the same contribution limits as traditional IRAs. Roth IRAs have income limits, so not everyone qualifies for this type of account. In 2014, individuals and heads-of-household can have an AGI of $114,000 to $129,000 and still contribute to a Roth IRA; for married couples filing jointly, that number starts at $181,000. The income limits change annually, so check with the IRS or your financial advisor before investing.
A SEP-IRA is a Simplified Employee Pension Individual Retirement Account. The rules are much more complex that with traditional or Roth IRAs; often these accounts are used by self-employed business owners who have few or no employees. SEP-IRAs have the same general features as a traditional IRA, but with much higher contribution limits. Money cannot be withdrawn before you reach the age of 59 ½ and you must begin taking distributions by the age of 70.
A SIMPLE IRA us another type of retirement plan used by many small-business owners. SIMPLE is an acronym for Savings Incentive Match PLan for Employees, and allows employers to match at up to 3% of their employees’ contributions. In 2014, the contribution limit is $12,000 per person, and “catch-up” contributions for people 50 and older is limited to $2,500. The SIMPLE IRA is an alternative to 401(k) plans for small employers and for people who are self-employed. Similar to traditional IRAs, deposits are tax-deductible, and the business owner can act and both employer and employee, meaning they can deposit both the maximum contribution and the 3% employer match.
YOU CAN HAVE MORE THAN ONE IRA
Traditional and Roth IRA contribution limits are consolidated, which means you may contribute a total of $5,500 to any combination of traditional and Roth IRA accounts.
However, you can make contributions to a SEP or SIMPLE IRA in addition to your traditional or Roth IRA. It’s a good idea to seek financial advice to determine your contribution limits and discover the maximum amount of tax shelters for which you qualify.