What is an IRA?

 

“Financial peace isn’t the acquisition of stuff. It’s learning to live on less than you make, so you can give money back and have money to invest. You can’t win until you do this.“.png

An IRA is an individual retirement account. It allows you to save money for retirement in a taxed advantage way. It is an account set up by a specific financial institution that allows an individual to set aside funds for retirement savings. There are several types of IRAs as of 2020: they are traditional IRAs Roth IRAs sep IRAs and simple IRAs. These four have some minor differences and some significant differences which I will explain. In my opinion, TD Ameritrade offers the best options for opening an IRA, they don’t have a minimum deposit nor an online trading fee, so they are my go-to if you plan to open up one of these accounts.

Traditional IRA

A traditional IRA is the most common form of an IRA. It is an individual retirement account in which you can contribute pre-tax or after tax dollars, which gives you immediate tax benefits if your contributions are tax deductible. With this kind of IRA your money grows tax deferred, but the downside is  you’ll pay ordinary income tax on your withdrawals, and you must start taking distributions after age 72. To be eligible for a Traditional IRA, a person must have received earnings from work during the year and be under age 70 ½. an individual can only contribute up to $6000 but they cannot contribute more than their taxable compensation for that year. In general, deadlines for contributions to an IRA are in the middle of April for the previous tax year.  Besides in 2020 contributions are allowed later due to COVID-19.

IRAs can be tricky when withdrawing early, some people do not realize that there can be a 10 percent tax penalty for withdrawing the funds before age 59 ½. But you are allowed to use Traditional IRA money to pay for qualified college expenses without paying an early distribution penalty, although you’ll pay taxes on the distribution. Another good perk of Traditional Ira is You can use up to $10,000 toward the purchase of your first home.

Roth IRA

The Roth IRA was founded in 1997 by William Roth a former Delaware senator. this kind of IRA allows qualified withdrawals on a tax-free basis.  A Roth IRA is similar to a traditional with some minor differences, Roth IRAs are funded with after-tax dollars; the contributions are not tax-deductible. But once you start withdrawing funds, the money is tax-free, unlike a traditional IRA. These kind of IRAs are best when you think your taxes will be higher in retirement then they are now. If you are below the age of 50 you can contribute up to $6000 and when your over 50 you can contribute a maximum of $7000. 

Anyone with a taxable income can open and contribute to their Roth IRA-as long as certain requirements are made. You can’t contribute to a Roth IRA if you make too much money. In 2020, the limit for singles is $139,000. For married couples, the limit is $206,000. so if you make more then that per year a Roth IRA is not for you.  All brokerage firms offer a Roth IRA and i suggest going with Charles Schwab if you plan on opening one, they have the best features in my opinion. Your risk tolerance and investment preferences are going to play a role in choosing  Certain providers  charge you an account inactivity fee if you leave your investments alone for too long. Some providers have more diverse stock or exchange-traded fund offerings than others; it all depends on the type of investments you want in your account.

SEP IRA

 

A Simplified Employee pension Plan is what SEP stands for. This type of plan allows employers to contribute to traditional IRAs set up for employees. A business of any size or even a self employed individual, can establish a SEP. SEP’s are best for self employed business owners with few or no employees. People who use SEP’s can save up to $56,000 a year in tax write offs. If you have employees whom the IRS considers eligible you must contribute on their behalf, and those contributions must be an equal percentage of compensation to your own.

Employees who are eligible for SEPs have to be 21 years or older and have worked for you for as long as 3 years. If you want to put away 10% of your money into your SEP as an employer you also have to put 10% away to your employee. Employees own and control their accounts. SEPs are only worth it if you are self employed otherwise your gonna have to match what you put in your own SEP to employees SEPs.

Contributions are tax-deductible, including those made to employee accounts. You can deduct the lesser of your contributions or 25% of compensation, subject to the compensation cap ($285,000 in 2020; $280,000 in 2019). If you’re self-employed, your deduction is 25% of net self-employment income. I am personally familiar with SEPs because my father has one. I think their great for growing your money in the stock market while avoiding taxes. I have already made him a 27% return of his tax free money within 4 months. If your a sole proprietor self employed business owner I totally recommend looking into SEP IRAs.

Simple IRA

A SIMPLE IRA plan (Savings Incentive Match Plan for Employees) allows employees and employers to contribute to traditional IRAs set up for employees. It is ideally suited as a start-up retirement savings plan for small employers not currently sponsoring a retirement plan. These plans are used for small businesses with 100 or fewer employees. What makes a SIMPLE IRA unique is that the employer is required to make a contribution on the employee’s behalf – 
 Employers can choose to make a non-elective contribution of 2% of the employee’s salary or a dollar-for-dollar matching contribution of the employee’s contributions to the plan up to 3% of their salary. 

These type of IRAs have minimum paper work and are easy to setup. All you need to set one up is an initial plan document and annual disclosures from your employer. Employers get tax deductions for contributions they make towards employees. Employees may contribute up to $13,000 for the 2019 tax year ($16,000 for employees age 50 or older) and $13,500 for the 2020 tax year ($16,500 for employees age 50 or older). Employee contributions aren’t required every year. Unlike SEP IRAs, SIMPLE IRAs allow employees to make contributions. What makes a SIMPLE IRA unique is that the employer is required to make a contribution on the employee’s behalf – 
 

There is no age restrictions in opening up one of these accounts. All employees are eligible if they made at least $5000 from there employer within the last two years. If you withdraw before age 59½, you’re subject to a federal penalty tax of 25% if you take the distribution within the first 2 years of participating in the plan and 10% if taken after that time. SIMPLE IRAs have higher contribution limits than traditional and Roth IRAs, and it’s cheaper to set up and run a SIMPLE IRA plan than it is to administer many other workplace retirement plans.

Conclusion

Whether its any of these four IRAs get started in one. If your employer matches you or matches you with a percentage each time you contribute max out your contributions.  The money that is sitting in your savings account earning little to no interest could work harder for you in an IRA with safe investment choices. Opening an IRA is a step towards retirement and as humans we all want that. Open up an IRA today! I highly suggest using Charles Schwab due to easy navigating great customer support and overall a great broker!

PS: If your looking to open an account use this link 🙂

http://www.schwab.com/public/schwab/nn/refer-prospect.html?refrid=REFERCGQCXYRR



Categories: Financial Advice

2 replies

  1. Good blog about IRAs. Informative and easy to understand. Well done!
    Suggestion for another blog. Discuss if converting IRA to Roth IRAs makes sense in the current environment with historically low tax rates.
    Of course this would be geared to older investors like me.

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