IRA Guide: Which One Is Right for You?

No matter where you are on your retirement journey, contributing to an Individual Retirement Account (IRA) is a significant milestone in creating your ideal retirement lifestyle. Though there are different types of IRAs, all of these tax-advantaged savings accounts can help you save and invest to fulfill your long-term financial goals. Take a look at this IRA guide to see which one might benefit you the most.

Types of IRAs

While the Traditional IRA and the Roth IRA are the most commonly known, here is a brief overview of some of the types of IRAs you may come across.

Traditional: Contributions made to a traditional IRA are tax-deductible and are tax-free until retirement. Upon retirement, withdrawals are taxed at the ordinary income rate. At age 72, you must begin taking Required Minimum Distributions.
Roth: Contributions to a Roth IRA are not tax-deductible, but upon retirement, withdrawals can be made tax-free. Unlike a traditional IRA, there are no RMDs.
Simplified Employee Pension (SEP): This is a traditional IRA which is set up by an employer for employees, and the employer gets a tax benefit. Like a traditional IRA, contributions are tax-free and taxed upon withdrawal in retirement.
Savings Incentive Match Plan for Employees (SIMPLE): Employees can contribute to this type of IRA through their employer via salary deferral.

What’s the difference between a 401(k) and an IRA?

401(k) plans are only offered through employers and there are rules in place concerning employees’ eligibility to participate in those retirement plans. Conversely, IRAs can be set up individually and are a good option when or if you do not have access to an employer-sponsored retirement plan. You can have both a 401(k), if available to you through your employer, and an IRA.

Note: If neither you nor your spouse has an employer-sponsored retirement plan, traditional IRA contributions are fully deductible. If there is such a plan in place, the deductions are gradually phased out depending on your modified adjusted gross income.

Contribution Limits to IRAs and Penalties

As of 2022, the yearly contribution to a traditional or Roth IRA is $6,000. People aged 50 or over are allowed a catch-up contribution of an additional $1,000.

If you need to withdraw your savings from a traditional IRA before age 59 ½, you will incur a 10% penalty fee plus get taxed on the withdrawal at your ordinary income rate. There is no penalty for withdrawing your contributions from a Roth IRA, though there are income limits for contributing to one. If you happen to exceed the income limits of a Roth IRA and still contribute, you may face a 6% tax penalty.

Which IRA choice is right for you?

When considering contributing to a traditional IRA versus a Roth IRA, there are a few factors to think about. As mentioned, each IRA gives you a tax break - but the timing on that tax break differs. Would you rather defer tax with a traditional IRA and get taxed later, or get taxed now and enjoy the tax-free growth of a Roth?

You might also consider whether you think you will be in a higher tax bracket in retirement than you are currently. If you’re in a higher tax bracket once you’re ready to retire, then a Roth IRA might be more appropriate. Otherwise, a traditional IRA might be better suited for your needs.

Discuss your IRA options with Chatterton and Associates

If you want to open or start contributing to an IRA, it’s best to consider your options with your financial and tax professionals. Doing so can help you weigh the benefits and risks before you make a decision that could potentially have unintended tax implications.

Sincerely,

The Team at Chatterton & Associates

Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Federal tax laws are complex and subject to change. This information is not intended to be a substitute for specific individualized tax or legal advice. Neither Royal Alliance Associates, Inc nor its representatives provide tax or legal advice. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.