Defining differences in IRAs: choosing what is right for you

Stack of Bank Note and Pen Calculator On Note Book
KJ: An IRA stands for “Individual Retirement Arrangement” (you thought I was going to say account, didn’t you?). It’s a way to help you save for your retirement in a tax-advantaged way. Sounds simple, right? While you could walk into a bank or brokerage/investment company to open an IRA in a matter of minutes, it’s best to know the different types and uses of each kind. So, we’ll break it down for the IRA basics on what you need to know. A professional financial advisor or CPA can help you navigate which may be best for your situation.

With the compounding effect of your money over time, you’re just throwing money away each year if you don’t take advantage of these accounts as a twentysomething (or thiry- or forty-something)! We were fortunate enough (my background and studies) that we opened our first IRAs in our teens. It now doesn’t seem like a whole lot, but at the time, it was a lot of money! And, it was less about the actual contribution itself than it was about the act of saving and thinking about future savings that has helped us today to create, set, and accomplish our goals.

There are all kinds of IRAs (Traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs to name a few), and understanding the differences is important, so we prepared a handy-dandy chart for you to reference. Enjoy!

Traditional IRA Roth IRA SEP-IRA (Simplified Employee Pension) SIMPLE IRA
Current Taxation Deduct current year contributions on your tax return (as able) No tax deduction Deduct current year contributions on your tax return Deduct current year contributions on your tax return
Ongoing Taxation Interest and gains are tax-deferred Interest and gains are tax-deferred Interest and gains are tax-deferred Interest and gains are tax-deferred
Future Taxation Distributions are taxable as ordinary income Distributions are NOT taxable Distributions are taxable as ordinary income Distributions are taxable as ordinary income
Contribution Limits for 2013 $5,500 $5,500 The smaller of 25% of income (20% for self-employed) or $51,000. Employee contributions cannot exceed $12,000.
Contribution Limits for 2014 $5,500 $5,500 The smaller of 25% of income (20% for self-employed) or $52,000 Employee contributions cannot exceed $12,000
Catch-Up Contributions for Over Age 50 $1,000 $1,000 N/A $2,500 (as allowed by the plan)
Contribution Deadline April tax filing deadline of each year April tax filing deadline of each year Personal return tax filing due date of each year (including extensions) Business return tax filing due date of each year (including extensions)
Required Minimum Distributions (RMD) at Age 70 ½ Yes No Yes Yes
Phase-Out for Contributions Varies depending on whether you are covered by an employer’s retirement plan. See IRS website for more details.(1) $178,000 – $188,000 for Married Filing Jointly for 2013 N/A N/A
Withdrawals Before age 59 1/2 Earnings and deductible contributions subject to income taxes AND a 10% penalty. Withdrawals are proportional to all lifetime deductible/non-deductible contributions. Earnings are subject to income tax and a 10% penalty. Generally, withdrawals are treated as your contributions being withdrawn first (which are not subject to tax or the 10% penalty). Subject to income taxes AND a 10% penalty. Subject to income taxes AND a 10% penalty.
Notes: Great if you think you will be in a lower tax bracket in retirement. Great if you think you will be in a higher tax bracket in retirement. Also, these assets are good for “generational” monies to pass to heirs/children. Cheaper, easier alternative to a 401(k) or other expensive employer retirement plan. Cheaper, easier alternative to a 401(k) or other expensive employer retirement plan.

Note that with a traditional IRA, you could have deductible and/or non-deductible contributions to the account. However, with a Roth IRA, once your income gets above the phase-out, you are no longer able to contribute to the account. See also the IRS website on IRAs for more information.

(1) Read more: IRA deduction limits.
Since Simplified Employee Pension (SEP) and Savings Incentive Match Plan for Employees (SIMPLE) aren’t common, see also the IRS website for more information: SEP IRAs and SIMPLE IRA. Note that if you participate in an employer plan (401(k), 403(b), etc.), your SIMPLE contributions apply to the $17,500 annual contribution limit for 2013 and 2014.

    Tell us about your retirement plans.
    Do you have an IRA?
    What types of IRAs do you use?
    What is preventing you from using an IRA?

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