What Is an IRA, Anyway?
No matter your age or profession, once you enter the workforce, you should be able to confidently answer the question: "What is an IRA?"
The answer: one of the most important tools to save for retirement and become financially independent. IRA stands for "individual retirement account," and as you'll see, there are several different types you can use to get tax-advantaged savings and growth. Most importantly for the immediate future, you have until April 15 to max these accounts out for the 2013 fiscal year.
What is an IRA? It's many different things
There are four primary types of IRAs that individuals should be aware of. Based on your employment status and your income, you may not be eligible for all of them.
Type of IRA | Who Can Use It? | When are Taxes Paid? | Yearly Contribution Limits for 2013 Tax Year |
|---|---|---|---|
Traditional | Anyone under 70.5 who earns taxable income. However, the amount that's deductible depends on whether you have a retirement account through your employer, and what your income is. | When money is withdrawn during retirement, at your then-tax rate | $5,500 (or $6,500 if you are over 50) |
SEP | Anyone who earns freelance income, is self-employed, or works for a company that chooses to set up SEP IRAs (and has worked for the company in three of the past five years) | When money is withdrawn during retirement, at your then-tax rate | The lesser of 25% of compensation for employees, or 20% for self-employed (up to $255,000), or $51,000 |
SIMPLE | Anyone who works for a company with 100 or fewer employees (including the self-employed and freelancers), and whose company chooses to participate | When money is withdrawn during retirement, at your then-tax rate | Employer is required to either provide 3% match or 2% of salary (up to $255,000 salary). Total limit including employer and employee contributions is $12,000 ($14,500 if over 50). |
Roth | Anyone who has taxable income, though the amount you are allowed to put in may be limited if you earn more than a certain amount in any given year | Before money is ever put into the account | $5,500 ($6,500 if over 50) |
Source: IRS
When it comes to understanding the tax benefits of these types of accounts, the following graphic breaks down where the advantages lie.
For most people reading this, the best option is ...
That's a lot of information to swallow, but the basics are actually pretty simple. If you have a retirement plan through your employer, the Roth IRA is usually the best option for any extra money you want to set aside.
Though contributions aren't deductible, they grow and can be disbursed tax-free. And if, for any reason, you need the money before you reach retirement, you can withdraw any principal you've contributed and has been in your Roth for more than five years without any penalty.
If you're not like most ...
If you're self-employed or a freelancer, SEP and SIMPLE IRAs are attractive options. You could still be eligible for these IRAs if you aren't self-employed, but that's a decision that your employer -- not you -- has to make.
SIMPLE plans require contributions from employers and have lower contribution limits. SEPs, on the other hand, are highly lucrative for the self-employed, as you can sock up to $51,000 away for 2013 and have that money deducted from what you owe the IRS at the end of every year.
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