What is an IRA Anyway?
You’ve likely heard the term IRA (Individual Retirement Account) before, among a bewildering amount of other retirement jargon. However, like many people, you’re probably still not sure what it is and what it can do for you. So, pull up a chair, grab a cup of coffee, and let’s talk about IRAs in plain English.
IRA Basics
- An IRA is not an investment itself (i.e. stocks, bonds, mutual funds), but rather an investment account you put funds in to use for investing.
- As a retirement-specific investment account, you receive certain tax breaks, depending on which type of IRA you choose to contribute to.
- You have control of how and where your IRA contributions are invested (unless you want to hire someone else to manage that for you).
- With a Waldo State Bank IRA* you can move funds around without penalty from the IRS before retirement as long as they remain in the IRA.
*Other financial institutions may impose a penalty or transfer fee. - One of the advantages of an IRA is that you can contribute to one even if you’ve already maxed out your 401(K) contributions for the year.
- You can deduct your IRA contributions on income tax returns if you don’t also have a 401(k) you are deducting (some restrictions apply based on income).
- You are able to make contributions for the prior year through April 15. These contributions are typically done at the advisement of your tax preparer.
Types of IRAs
Now, you may be wondering if all the other terms you hear people tack onto “IRA” are just more jargon to try and sound impressive. We get it, it sounds suspiciously excessive, but they’re all real. There are actually four different kinds of IRAs, each with different qualifications and ways in which they serve you, so let’s break them down.
Traditional IRA
- Pre-tax Contributions: Yes
Your contributions are withdrawn before taxes, either through withdrawal from your paycheck via your employer or through your financial institution by reconciling the net impact when you do taxes.
- Withdrawal Tax: Yes
Taxes will be taken upon withdrawal.
- Taxed Growth: Tax-Deferred
Your investment gains will not be taxed until you make a withdrawal (making your money grow faster).
- Early Withdrawal Penalties: Yes
Withdrawals made before age 59 ½ will result in a 10% penalty.
- Contribution Limits: Yes
You cannot contribute more than $6,000 annually until the age of 50 when you can contribute up to $7,000. **
Roth IRA
- Pre-tax Contributions: No
Contributions are made after taxes.
- Withdrawal Tax: No
Taxes are taken upon withdrawal.
- Taxed Growth: Tax – Free
Unlike most IRA accounts, your investment gains from a Roth IRA are not taxed at all.
- Early Withdrawal Penalties: No
There are no penalties for withdrawing prior to retirement age as long as you have contributed for at least five years.
- Contribution Limits: Yes
You cannot contribute more than $6,000 annually until the age of 50 when you cannot contribute more than $7,000. **
SEP (Simplified Employee Pension) IRA
This is an exclusive IRA account that is only available to people that are both self-employed and have no employees.
- Pre-tax Contributions: Yes
Your contributions are withdrawn from your paycheck before taxes.
- Withdrawal Tax: Yes
Taxes will be taken upon withdrawal.
- Taxed Growth: Tax-Deferred
Your investment gains will not be taxed until you make a withdrawal (making your money grow faster).
- Early Withdrawal Penalties: Yes
Withdrawals made before age 59 ½ will result in a 10% penalty.
- Contribution Limits: Yes
You can contribute up to $57,000 annually or 25% of your income, whichever is less. **
SIMPLE (Savings Account Incentive Match for Employees) IRA
This is an exclusive IRA that is only available to small businesses with 100 employees or less.
- Pre-tax Contributions: Yes
You can have your contributions withdrawn from your paycheck before taxes.
- Withdrawal Tax: Yes
Taxes will be taken upon withdrawal.
- Taxed Growth: Tax-Deferred
Your investment gains will not be taxed until you make a withdrawal (making your money grow faster).
- Early Withdrawal Penalties: Yes
Withdrawals made before age 59 ½ or less than two years after the opening, the account will result in a 25% penalty.
- Contribution Limits: Yes
You cannot contribute more than $6,000 annually until the age of 50 when you cannot contribute more than $7,000. **
**Based on 2020 contribution limits dictated by the IRS.
So, there you have it, IRAs in plain English. We hope you feel more confident in understanding your retirement options after reading this. Do you want to continue learning about your retirement options? Check out last week’s blog about Leveraging Your HSA for Retirement or connect with us here to find out which one is best for you.
