What Is an IRA, Anyway?

No matter your age or profession, once you enter the workforce, you should be able to confidently answer the question: "What is an IRA?"

The answer: one of the most important tools to save for retirement and become financially independent. IRA stands for "individual retirement account," and as you'll see, there are several different types you can use to get tax-advantaged savings and growth. Most importantly for the immediate future, you have until April 15 to max these accounts out for the 2013 fiscal year.

What is an IRA? It's many different things
There are four primary types of IRAs that individuals should be aware of. Based on your employment status and your income, you may not be eligible for all of them.

Type of IRA

Who Can Use It?

When are Taxes Paid?

Yearly Contribution Limits for 2013 Tax Year

Traditional

Anyone under 70.5 who earns taxable income. However, the amount that's deductible depends on whether you have a retirement account through your employer, and what your income is.

When money is withdrawn during retirement, at your then-tax rate

$5,500 (or $6,500 if you are over 50)

SEP

Anyone who earns freelance income, is self-employed, or works for a company that chooses to set up SEP IRAs (and has worked for the company in three of the past five years)

When money is withdrawn during retirement, at your then-tax rate

The lesser of 25% of compensation for employees, or 20% for self-employed (up to $255,000), or $51,000

SIMPLE

Anyone who works for a company with 100 or fewer employees (including the self-employed and freelancers), and whose company chooses to participate

When money is withdrawn during retirement, at your then-tax rate

Employer is required to either provide 3% match or 2% of salary (up to $255,000 salary).

Total limit including employer and employee contributions is $12,000 ($14,500 if over 50).

Roth

Anyone who has taxable income, though the amount you are allowed to put in may be limited if you earn more than a certain amount in any given year

Before money is ever put into the account

$5,500 ($6,500 if over 50)

Source: IRS

When it comes to understanding the tax benefits of these types of accounts, the following graphic breaks down where the advantages lie.

For most people reading this, the best option is ...
That's a lot of information to swallow, but the basics are actually pretty simple. If you have a retirement plan through your employer, the Roth IRA is usually the best option for any extra money you want to set aside.

Though contributions aren't deductible, they grow and can be disbursed tax-free. And if, for any reason, you need the money before you reach retirement, you can withdraw any principal you've contributed and has been in your Roth for more than five years without any penalty.

If you're not like most ...
If you're self-employed or a freelancer, SEP and SIMPLE IRAs are attractive options. You could still be eligible for these IRAs if you aren't self-employed, but that's a decision that your employer -- not you -- has to make.

SIMPLE plans require contributions from employers and have lower contribution limits. SEPs, on the other hand, are highly lucrative for the self-employed, as you can sock up to $51,000 away for 2013 and have that money deducted from what you owe the IRS at the end of every year.

While we're on the subject of taxes, look at what the IRS is daring you to do!
Recent tax increases have affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "The IRS Is Daring You to Make This Investment Now!," you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.


Read/Post Comments (0) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2891459, ~/Articles/ArticleHandler.aspx, 11/22/2014 4:14:59 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement