Types of IRA’s All You Need To Know!
An IRA is a retirement savings account. There are different types of IRAs. IRA stands for Individual Retirement Account. Taxes on capital gains and dividends are deferred until withdrawal.
Also, contributions may be tax-deductible.
While some IRA contributions are nondeductible.
However, this depends on the types of IRAs account.
What Is An IRA?
IRAs are great investment options that allow for monies to compound faster when compared to traditional brokerage accounts.
You still will have pay ordinary taxes when withdrawing the funds.
IRA’s are great vehicles to save more money for retirement.
Simply put you are just delaying paying the taxman while allowing your hard-earned monies to grow faster.
All types of IRA’s investments grow tax-free. Additionally, some type of IRA’s allows you to withdraw money tax-free
How To Open An IRA?
You can open an IRA account with several financial institutions.
Such as banks, Credit unions, and brokerage firms.
You can either go to a physical location or do it online in the comfort of your home.
There are no fees associated with opening an account.
Who Is Eligible To Contribute To An IRA?
Anyone can contribute, as long as they have W-2 income, or any other form of taxable compensation, such as 1099.
The age limit for IRA contributions is 70 ½ years old, except for Roth IRA.
How Much Can You Contribute To An IRA?
The contribution limit for 2020 is $6,000 remaining unchanged from 2019.
While catch-up contributions for ages 50+ is an additional $1,000, for a total of $7,000, remaining the same as 2019.
These contribution limits apply to all IRA’s across the board.
This means that anyone can contribute up to $6,000. Furthermore, if you are 50 years or older you can contribute an additional $1,000 for a grand total of $7,000.
It is very important to pay attention to these limits as they change mostly every year.
Contributions can be made during the calendar year, and up to tax filing due date of the following year.
For example: For the year 2020 you can contribute to your IRA anytime between January 1, 2020, until April 15, 2021.
Also, the $6,000 limit applies to contributions made accross all IRAs.
For Example: If you have a Traditional IRA and a Roth IRA and you contribute to both IRAs in the same calendar year, you cannot exceed the $6,000 contribution limit for the year between the two IRAs accounts.
There is no requirement to contribute at all.
You decide how much and how often you can contribute.
Or you can skip years without making any contributions.
Historical IRA Contribution Limits
|Year||Contribution Age 49 & below||Contribution Age 50+ plus catchup|
What If You Contribute More Than The Annual Limit Set By The IRS
When you over contribute to an IRA it is called an excess contribution.
You will be charged a 6% tax penalty for over-contribution to an IRA.
If you have made on over-contribution, you have a few options to fix it.
- You need to withdraw the excess contributions before the tax filing due date, including its earnings.
- Apply the excess contribution to the following year. Make sure to reduce the maximum allowed contributions by the excess contributions made. Also, with this option, you will still need to pay the 6% tax penalty on the excess contribution.
What Are The Types Of IRAs
1- Traditional IRA
With a Traditional IRA in many cases, your contributions are tax-deductible.
Your money grows tax-deferred. You save money on taxes NOW.
You will not pay taxes until you retire and take the money out.
There are no income limitations. In this case “The sky is NOT the limit”.
Take a look at my post Guide to traditional IRA for more in-depth information about this type of IRA.
Income limitation applies when it comes to deducting taxes.
|Year 2020||Amount Deductible||Single||Married|
|Income||$6,000||Less than $64,000||Less than $103,000|
|Income||Phase out||> $64,000 < $74,000||> $103,000 < $123,000|
|Income||$0||More than $74,000||More than $123,000|
2- Roth IRA
Contributions to a Roth IRA are not tax-deductible.
Because your contributions are made with after-tax money.
Just like a traditional IRA your contributions, capital gains, and dividends grow tax-free.
Unlike the traditional IRA, there is no age limit for stopping contributions.
This means that you can still contribute after you reach age 701/2 years of age.
When you are ready to withdrawal money, also known as taking a distribution, you will not incur taxes.
Distribution from a Roth IRA is tax-free.
The is no required minimum distribution (RMD).
You can leave your money in the Roth IRA for as long as you want without withdrawing a single penny.
This type of IRA makes it the best for inheritance gifts.
Keep in mind that there are income limitations for contributing to a ROTH IRA.
If your Adjusted Gross Income (AGI) exceeds the limits shown below, then contributions start to phase out.
If you stay within AGI limits, then you can contribute the maximum allowable.
|AGI||Full Amount||Less than $122,000||Less than $193,000|
|AGI||Phase-out||> $122,000 < $136,999||> $193,000 < $203,000|
|AGI||Can’t Contribute to ROTH||More than $137,000||More than $203,000|
3- Simple IRA
SIMPLE IRA stands for Savings Incentive Match Plan for Employees Individual Retirement Account.
Small businesses and self-employed individuals can establish this type of account.
Just as a traditional IRA the money grows tax-deferred until you withdraw the funds at retirement.
Which then will be taxed at your current tax bracket.
The contribution limit for 2020 is $13,500.
If you are 50 years of age or alder your catch up contribution is $3,000, for a total of $16,500.
4- SEP IRA
SEP IRA stands for Simplified Employee Pension Individual Retirement account.
This is a plan that can be established by small businesses, self-employed people, contractors, and freelancers.
Contributions are tax-deductible just like a traditional IRA.
And your money grows tax-deferred until you make withdrawals. Distributions will be taxed at your current tax bracket at retirement age.
Contributions limits for 2019 cannot exceed the lesser of:
- 25% of employee’s compensation or
What Are The Benefits Of An IRA?
- Contributions are tax-deductible, excluding Roth IRA contributions.
- Money grows tax-deferred.
- Distributions, including earnings and gains, are tax-free ONLY for Roth IRA.
- Bankruptcy protection.
How To Invest In An IRA?
IRA’s have a big selection of investment products.
Such as Stocks, Bonds, Mutual Funds, Annuities, and ETFs.
Based on your risk tolerance you can set your asset allocation of the different asset classes.
Let’s say for example that you are a recent college graduate age 22 and are starting to invest in your 401k or IRA. Your asset allocation can be 90% stocks, 10% bonds. In this age category, there are some people that have an allocation of 100% stocks.
This is an aggressive growth allocation. But you have 40 years of investments ahead of you.
The market will have fluctuations in the forms of corrections and even market crashes.
But it will not affect you per se since you are in it for at least 40 years and have plenty of time to recover.
On the other hand, if you are already an AARP member in your 50’s then your asset allocation should be more conservative.
At this stage, you want growth but also asset preservation.
Your allocation should look something like this; 60% stocks; 40% bonds.
Some people still lose sleep with this allocation.
If you fall into this category you can go with an even more conservative allocation such as 50% stocks-50% bonds.
How To Take IRA Distributions or Withdrawals?
Once you reach 59 ½ years of age you can start withdrawing money from any type of IRA without penalties.
This rule applies across all IRA accounts.
1- Traditional IRA
You can begin to take distributions after the age of 59 ½.
There is no requirement to start taking distributions until age 70 ½.
This is called RMD, Minimum Required Distribution.
If you have not reached the age of 59 ½ you can withdraw your (contributions ONLY), tax-free as well as free of penalties.
2- Roth IRA
After the age of 59 ½, you can take distributions from your ROTH IRA.
There are no required minimum distributions (RMD), unlike the traditional IRA.
The distributions are tax-free (Federal and State) as well as penalty-free as long as the ROTH IRA account has been open for more than five years.
The Roth IRA 5 year rule requires you to keep the account for 5 years before you withdraw the earnings without penalties.
What If Your ROTH IRA Account Was Open Less Than Five Years Ago?
If you take a distribution, you will be taxed only on your earnings NOT the contributions.
Also, you will NOT be charged penalties.
If you have not reached the age of 59 ½ you can withdraw your (contributions ONLY) tax-free as well as free of penalties.
This is because your contributions to Roth IRAs are made with after-tax dollars.
Is An IRA The Same As A 401k?
IRA’s and 401(k)’s are not the same, even though they both are tax-deferred retirement savings accounts.
401(k) is an employer sponsor plan. Therefore, you need to be employed by a company to participate.
While IRA only requires that you have taxable income.
In my Complete retirement guide to 401k for beginners, you will get more information about this very beneficial and tax-deferred retirement savings accounts.
However, both types of account IRA and 401k are used for retirement purposes.
To wrap it up, I hope that after reading my article you have a better understanding of the different types of IRAs.
If you have questions or opinions do not hesitate to ask and post them in the comments below.