Generally speaking, IRAs are a good idea for people who don’t have 401(k)s or want more for their retirement than they can save in their 401(k).
They may want to be certain that they have done enough to provide for their retirement by adding an IRA to their or to a spouse’s retirement financial planning portfolio.
Understanding your various options is important. Getting help from a qualified financial advisor or financial planner is equally important as they can guide you through the process and ensure you get the best IRA for your unique needs.
What is a Traditional IRA?
In simplest terms, an IRA allows you to establish your own retirement fund and provides tax advantages for your retirement savings. Specifically, you are not taxed on deposits to your IRA, however, you are taxed on withdrawals from it. The IRS defines it as an individual retirement account that is an “individual retirement arrangement” in IRS Publication 590.
What is a Roth IRA?
Roth IRAs are similar in concept to traditional IRAs with the most significant difference being how they’re taxed. A Roth IRA is funded with “after-tax” dollars. As such, the contributions are not tax-deductible, but when you start withdrawing your retirement funds, there are no taxes to be paid.
After Tax Plan
Another type of retirement plan, sometimes offered by employers through their 401(k) program is an “after tax” retirement plan. This plan can get confusing as the contributions are made after tax (like a Roth) but the appreciation is not sheltered from tax. Instead, taxes are due on that portion of the 401(k) that is classified as earnings and thus has not yet had any taxation. When you roll over this type of plan to an IRA, part of it can be rolled over to a Roth IRA (the part that was already taxed – your contribution amount only) and the other portion (the earnings/appreciation) can be rolled over to a traditional IRA.
What IRA Is Better for You?
Again, it is advisable to seek the help of a qualified financial planner to help you make this decision. If you or your spouse already have a 401(k) plan at work, there are limitations to participating in Traditional IRA and Roth IRAs as well.
Let’s have a quick look at a Traditional IRA and a Roth IRA. Which one is best for you and your future?
The first question to consider is when do you want to pay your taxes? As you are funding it or when you are withdrawing from it? For many people, paying the taxes later is a strong attraction to the traditional IRA. Although once you understand some other demands of the traditional IRA, you may want to consider the Roth IRA.
The Traditional IRA demands that you take required minimum distributions (RMDs) every year by April 1 starting in the year after you reach the age of 73 (for tax year 2022, the age for starting RMDs was 72). The RMD age will increase again to 75 in 2033. These forced RMDs do not take into consideration whether you actually need the money. As your balance drops, your tax-free growth will decline. For some, this may not be an issue, while others may find it to be a deal breaker.
Roth IRAs don’t have RMDs during your (as the account owner) lifetime, so your money can stay in the account and keep growing according to your personal preference. It can be left to grow for decades in fact. And if your Roth IRA is still around when you leave this earth, then your beneficiaries are not subject to income tax on withdrawals either and they have up to ten years to withdraw the balance.
- Both IRAs allow for beneficiaries, which is another key area to review
with a financial planner when determining what IRA is best for you.
Are there any key differences in the requirements of both that could
positively or negatively affect you? - Both IRAs also have limitations as to how much can be contributed to
the account annually.
Most Financial Planners will not recommend early withdrawals from IRAs as there can be penalties on income that has not yet been taxed.
As well, your overall growth will be slowed as the IRA balance decreases from the early withdrawal, which is not ideal for any retirement plan.
SIMPLE and SEP IRAs
There are two other types of IRAs that may be options for some people. These are the SIMPLE IRAs and SEP IRAs which employers can open, but individuals may not open unless the individual is self-employed or a sole proprietor.
- SIMPLE: Savings Incentive Match Plan for Employees
- SEP: Simplified Employee Pension
They allow for higher contribution limits and can also allow for companies to match contributions.
With the SEP IRA, the employer also receives a tax deduction for the matching contributions. Typically, the SEP IRA is closest to the traditional IRA with the employer contribution matching aspect.
The SIMPLE IRA is an option for many small businesses with 100 or fewer employees.
You also have the option to open a “Solo 401(k)” if you are a sole proprietor or solo business owner without employees.
As a business owner or 1099, there are a lot of options for retirement savings, Discussions with a financial planner and your CPA can be integral in making the most of your retirement savings and help you to achieve significant income tax savings over time.
When Should You Open an IRA?
The simple answer here is the sooner the better!
The critical mistake that too many people make is starting an IRA in their 40s or 50s when they could have started it in their 20s or 30s, or never starting one at all.
Keep in mind however if you are in your 40s or 50s or even your 60s and finally find yourself in a position to save for retirement, you absolutely should talk with a financial planner and get a plan that makes sense for you.
No matter what IRA is best for you, the most important thing to consider is that the sooner you begin the more your funds will increase, thus securing and providing for a more comfortable retirement that allows you to pursue all of your goals.
If you have questions, please reach out to us for a personal consultation.
This article is for general information only and should not be considered as financial, tax or legal advice. It is strongly recommended that you seek out the advice of a financial professional, tax professional and/or legal professional before making any financial or retirement decisions.
