As the longest economic recovery in modern history continues – we’re now into Year 10 – I am encountering more and more clients and potential clients worrying that a big market correction, if not an outright recession, is just around the corner. While I don’t have a crystal ball and can’t predict what is on the economic horizon, I do encourage clients to ALWAYS remain aware of the potential for a downturn so they can take steps to keep ahead of trouble. You can stay ahead of the curve with a well-chosen IRA.
One of the best things you can do for yourself is to take control of your investments through an Individual Retirement Arrangement (IRA), of which there are several variations. “Self-directed” does not refer to a specific type of account as much as it refers to your ability to control what assets you invest in.
Which type of IRA is best for you?
The answer to that depends on a number of factors, including your current financial situation and long-term goals. A trusted financial adviser can help you evaluate your situation and set a course for retirement wealth-building that best meets your needs and objectives. Much of the difference among account types stems from the tax advantages of each.
Here’s an overview of several plans to consider.
The best known and most popular type of IRA is the traditional IRA. Main features include:
- Contributions are tax deductible as long as you meet requirements
- Funds continue to grow tax-deferred until money is withdrawn or taken as a distribution.
- Withdrawals are taxed as ordinary income, but for most people, that happens at a point in their lives when they are in a lower tax bracket than when they earned the money.
Funds are meant to be left in the account to grow, without tax consequences, until the account holder reaches age 59½. That does not mean you cannot withdraw the money prior to that point, but if you do, you will be subject to certain tax penalties.
You may continue to make contributions until age 70½ , after which you must take Required Minimum Distributions. For the tax year 2018, the maximum annual contribution is $5,500 ($6,500 if you’re age 50 or older), or your taxable compensation for the year, if your compensation was less than this dollar limit.
The Roth IRA, named for Sen. William V. Roth, was introduced in 1997 to offer savers a different type of tax advantage. Contributions to a Roth IRA, are not tax-deductible in the year the funds are deposited. However, the after-tax dollars grow tax-free and distributions and withdrawals are not subject to taxes or penalties, provided you meet IRS requirements.
Contribution limits generally are the same as with a traditional IRA, although your Roth contributions may be limited based on your filing status and income.
You may contribute to a Roth IRA regardless of your age, and there are no required minimum distributions at age 70½. As long as you have earned income, you can continue to contribute to the account.
The Simplified Employee Pension (SEP) IRA is designed for small-business owners with fewer than 25 employees and enables them to forego a more complicated qualified plan such as a 401(k). Any type of employer (individual, partnership, corporation) can establish the plan. A SEP IRA is similar to a traditional IRA in requiring money to be left in the account until age 59½ (or else early-withdrawal penalties apply), RMDs take effect at age 70½, earnings grow tax-deferred until withdrawn, and then are taxed as ordinary income.
A major difference is that this is an employer plan, so individuals cannot contribute directly. Contribution limits also are much higher than allowed in a traditional IRA. Certain other restrictions also apply. Click here for more information about SEP IRAs from the Internal Revenue Service.
The Savings Incentive Match Plan for Employees (SIMPLE) IRA is another option for small businesses that have 100 or fewer employees and no other qualified plan. The type plan also has rules similar to a traditional IRA (in terms of tax advantages, withdrawals, etc.).
Features of a SIMPLE IRA, according to the IRS, include:
- An employee may choose not to contribute, but his or her employer is required to make an annual contribution of either a matching contribution up to 3% of compensation (not limited by the annual compensation limit), or a 2% nonelective contribution for each eligible employee
- The employee is always 100% vested in (or, has ownership of) all SIMPLE IRA money.
In addition to what has been discussed here, you can find more in-depth information on these plans, as well as a look at additional options, by clicking here to access the IRS’ website.