By Lindsey Anderson, CPA
Manager, Tax Services Group
If your employer does not offer a 401k program – or even if they do — IRAs are a common recourse for retirement savings. Once upon a time there was only one type available, but with the proliferation of IRA plans there are now several to choose from, each with their own set of advantages and drawbacks.
These include “traditional” IRAs, Roth IRAs, SEP-IRAs and SIMPLE IRAs. Some of these plans have similar features, but others have unique qualities. All of them can help your family put aside significant savings for retirement on a tax-favored basis.
Here’s what you need to know in choosing the IRA plan that’s right for you.
Traditional IRA
Traditional IRA’s can be funded with deductible and nondeductible contributions.
Deductible IRA Contributions — You can make an annual tax-deductible contribution to an IRA if you (and your spouse) are not an active participant in an employer-sponsored retirement plan, or if you are in an employer-sponsored plan under a certain level of income (which varies from year to year). You can contribute up to $5,500 a year in 2016 (plus an additional $1,000 if over age 50). You can also contribute to an IRA for a non-working spouse.
Traditional IRA contributions reduce your current tax bill, and investment earnings within the IRA are tax-deferred.
However, withdrawals prior to retirement are subject to full taxation, plus a 10% penalty before age 59½ (unless one of the several exceptions apply). Additionally, you must start making mandatory minimal withdrawals by age 70½, or the amount not withdrawn is taxed at 50%.
Nondeductible IRA Contributions – You can make annual nondeductible IRA contributions without regard to your coverage by an employer plan and without regard to your AGI. The earnings in a nondeductible IRA are tax-deferred within the IRA, but are taxed on distribution (and subject to a 10% penalty if you withdraw money before age 59 ½, unless one of the several exceptions apply).
Roth IRA
Roth IRAs differ in that contributions are taxed up front. Annual contributions to a Roth can be made up to the same amount that would be allowed to a traditional IRA, less the amount you contribute that year to non-Roth IRAs. You can only contribute to a Roth if your adjusted gross income doesn’t exceed certainly levels that vary by filing status.
Earnings within the IRA are tax-deferred just like a traditional IRA, but are tax-free if paid out after five years from when you first made a contribution, and upon reaching age 59½. (If both of the conditions are not met, taxes and penalties may result unless an exception applies.)
One notable benefit of a Roth IRA is that you can continue to make contributions after age 70½, and do not have to take minimum distributions as with a traditional IRA. This makes a Roth IRA an excellent wealth-building vehicle for your family.
It is possible to convert or “roll over” a traditional IRA into a Roth IRA. In doing so you are choosing to pay taxes on the amount of the investment (excluding any non-deductible IRA contributions) now as opposed to in the future. If you are expecting to have a low income year, it might be the perfect time to do so as you can take advantage of a lower tax rate.
SEP and SIMPLE IRA
Small businesses that want to keep the administrative costs of a retirement plan low may able to set up a simplified employee pension (SEP) or savings incentive match plan for employees (SIMPLE) IRA. Contributions are made to an IRA-type account in the employee’s name.
Annual contributions to these plans are controlled by special rules and aren’t tied to the normal IRA contribution limits. Distributions from a SEP IRA or SIMPLE IRA are subject to tax rules similar to those that apply to deductible IRAs.
If you are self-employed, individuals can contribute as much as 25% of his or her net earnings into an SEP up to $53,000, which is deducted from total income. You have until the due date of your individual income tax return (including extensions) to deposit your SEP contribution
If you need any assistance with choosing the right IRA, please call Lindsey Anderson in our Tax Services department at (317) 608-6699 or email [email protected].