When planning how to manage your retirement savings, there are many types of IRAs that you will have to consider.
While each type of individual retirement account has its merits, your decision will have to be based on what is best for you according to your circumstances and your retirement goals.
As such, it is important to fully understand how each of these different types of IRA accounts are structured, and how they will impact your retirement savings in the long run.
Armed with this knowledge of the various tax advantages and mechanisms of each type of IRA, you can successfully navigate the complex world of tax-deductible and non-tax-deductible IRAs.
Read on for an in-depth look at 10 of the most popular types of IRAs to consider in 2024 and beyond.
Traditional and Roth IRAs are among the most well-known types of IRAs that the majority of American retirees depend on. However, there are a lot more options than what most people would imagine.
While there may be a few important differences here and there, these different types of IRAs have a lot in common, especially when it comes to providing tax benefits for the account holder.
To understand more individual retirement accounts, consider the following:
Definition and Purpose of IRAs
An IRA (individual retirement account) is a long-term savings account that people who have earned income can use to save a part of their earnings for the future in a way that provides them with various tax advantages.
By diverting some of your funds to an IRA, your money grows tax-deferred in a secure retirement account where it will be waiting for you as soon as you reach the minimum retirement age.
In the meantime, you can deposit money into your IRA, as long as you do not breach the contribution limit set by the IRS for the current year.
The main purpose of opening one of the many types of IRAs available is to ensure that when you retire and no longer have earned income to depend on, you will still have enough money to live on, and perhaps, even do some of the things you have always wanted, such as traveling and seeing the world.
Role of IRAs in Retirement Planning
The different types of IRA accounts are designed, in most cases, to help self-employed individuals who do not have access to a 401(K), which is an employer-sponsored retirement plan.
Having an IRA will allow such individuals to effectively plan for their retirement while also enjoying the many tax benefits offered by the different types of IRAs.
Eligibility Criteria for Opening an IRA
In most cases, anyone with an earned income is eligible to open traditional and Roth IRAs, although their income level will also play a part in determining eligibility.
There are different rules for other types of IRAs that you will need to be familiar with before you open any particular individual retirement account.
Common Terms Associated With IRAs
When you open a traditional IRA, Roth IRA, or other retirement savings plan for the first time, there are many terms you will come across that may seem daunting to beginners.
To help make the transition a lot smoother, here is a breakdown of the definitions of some of the common terms used in IRAs:
Earned income – Any remuneration received from a job or self-employment.
401(k) – An employer-sponsored retirement plan that allows both employer and employee contributions to be made annually.
Taxable income – Any income that is earned in a taxable year.
Traditional or Roth IRA – Two of the most common types of IRAs used by the majority of retirement savings account holders.
After-tax dollars – The money that is contributed to the retirement account after income tax has already been deducted.
Tax deductible – A way of lowering your tax bill by getting a refund of taxes paid on the contributions made by the account holder.
Contribution limit – Limits set by the IRS on how much can be contributed to an IRA account in a particular year.
Minimum distributions – The specific amount of money that a retirement savings account holder must withdraw from their IRA each year from the age of 73 going forward.
Catch-up contributions – Additional contribution limits allowed for eligible individuals (age 50 or older) to help them grow their IRA portfolios faster.
Diverse Types of IRAs: An Overview
The following are 10 types of IRAs that are worth considering as you make plans to safeguard your financial future:
A traditional IRA is the most common type of tax-deductible individual retirement account for those who want to save for retirement.
Anyone with an earned income is eligible to open a traditional IRA, and the contribution limit for 2024 is set at $7,000. An additional $1,000 is allowed as catch-up contributions for eligible account holders (age 50 or older).
Funds are accessible without penalties as soon as the account holder reaches the age of 59 ½ and required minimum distributions start at the age of 73. While no tax is charged for contributions, income tax is charged upon withdrawals.
The defining feature of a Roth IRA is that you can invest after-tax dollars into the account. This means that, unlike traditional IRA contributions, you will be taxed when you make deposits so that the funds can be withdrawn tax-free.
Eligibility for a Roth IRA is also based on your income level or tax bracket. With Roth IRAs, you also do not have the required minimum distributions. Otherwise, a Roth IRA is similar to a traditional IRA in terms of contribution limits.
A Simplified Employee Pension (SEP) IRA is a form of retirement savings plan that is set up by small business owners for themselves and their employees. There is a minimum age and salary amount that needs to be met for eligibility for a SEP IRA.
Contributions to SEP IRA accounts are made by the employer and are limited to the lesser of either $69,000 for tax year 2024 or 25% of the employee’s compensation. While employee contributions are allowed to a SEP IRA, no catch-up contributions are made.
A SIMPLE IRA stands for Savings Incentive Match Plan for Employees. As the name suggests, this type of IRA gives employees of small businesses (100 or fewer employees) the chance to contribute to their retirement accounts.
With a SIMPLE IRA, employee contributions for 2024 are set at a maximum amount of $16,000, although catch-up contributions of up to $3,500 are allowed for eligible individuals (age 50 or older).
In some cases, individuals may be allowed to make traditional IRA contributions that do not come with regular tax advantages, such as making tax-free contributions.
This is called a non-deductible IRA, and it allows even individuals who are not eligible for a tax-advantaged traditional IRA to still make meaningful contributions to their retirement accounts.
The main advantage of a nondeductible IRA is that it allows you to save a lot more for your retirement because you will be free from the various IRS that apply to tax-deductible types of IRAs.
Additionally, there are ways to convert nondeductible IRAs to traditional or Roth IRA accounts.
While IRS rules state that a person needs to have earned income to be eligible for an IRA, there is a way around this if you are married.
Even if one person in the marriage is not working, or earning a very low income, a spousal IRA can allow the earning partner to make contributions to their spouse’s traditional and Roth IRAs.
However, to use a spousal IRA, couples need to fulfill the following requirements:
- The traditional IRA/Roth IRA must be in the name of the non-working (or low-earning) spouse.
- The total amount contributed to the spousal IRA be the lesser of double the annual IRA contribution limit or the couple’s joint taxable income.
- Contribution limits for the spousal IRA are the same as those for a traditional or Roth IRA.
- Couples must have taxable income and file a joint tax return to be eligible.
A self-directed IRA is a retirement savings account that offers the account holder greater control over portfolio management. Both traditional and Roth IRAs serve as the foundation for the structure of a self-directed IRA.
In addition to the typical investment options present in traditional and Roth IRAs, such as stocks, bonds, and mutual funds, a self-directed IRA account holder has the flexibility to invest in real estate, private companies, or even precious metals.
However, certain assets, like collectibles and life insurance, cannot be held in the account. Setting up a self-directed IRA necessitates a trustee to oversee the process, ensuring compliance with regulations and providing guidance on choosing top self-directed IRA options.
A rollover IRA is a retirement account that is created by transferring funds from an existing portfolio, such as a 401(K), to a traditional IRA or Roth IRA.
An in-depth look at rollover IRAs tells us that anyone with a workplace retirement plan from an eligible employer, such as a 401(K), 457, or 403(b) plan is eligible for a rollover IRA.
In terms of IRS rules and regulations, a rollover IRA is subject to the same tax, withdrawal, and penalty rules as a traditional IRA.
In many cases, a rollover IRA is the best option for individuals who want to consolidate their retirement accounts from a previous employer into one easy-to-manage plan.
The funds for an inherited IRA come from a deceased person’s estate. This retirement account can be a traditional IRA, Roth IRA, SIMPLE IRA, SEP IRA, or even a 401(K) plan.
Anyone who is listed as a beneficiary of the deceased person’s retirement account can open an inherited IRA.
However, once the funds have been transferred into the inherited IRA, no additional contributions will be allowed.
Also, the beneficiary is allowed to make withdrawals of any amount, at any time, from the inherited IRA without facing any IRS penalties.
The penalty-free withdrawals must be done according to the inherited IRA distribution rules.
Consult our detailed rules for inherited IRAs guide to find out how it works.
A backdoor IRA is a strategy that allows account holders to set up a Roth IRA even if their income level or tax bracket is not following the IRS recommendations.
Using a backdoor IRA, high-income earners can convert nondeductible traditional IRA contributions to a Roth IRA.
In many cases, such a move requires income tax to be paid on the funds before they are contributed to the Roth IRA.
There has been talk of eliminating the use of a backdoor IRA, but it is still a viable option for those who earn high incomes and would like to contribute more to their Roth IRA.
Delving Into Each IRA Type
Each of these types of IRAs has specific characteristics that make them suitable or unsuitable for your needs.
Considering that individual retirement accounts are designed to be long-term investments, it is best to look closely at a wide range of aspects that may affect the growth of your portfolio, such as tax benefits, contribution limits, withdrawal rules, IRS penalties, and other unique features.
The following is a brief explanation of each of these factors:
Unique Features and Benefits
When you look closely at your individual circumstances, you will realize that not all the above types of IRAs are the best fit for your financial goals.
Consider the simple choice between traditional and Roth IRAs. Here, the main concern will be the unique features of each type of IRA in terms of tax benefits.
If you think you will be earning a lot more money by the time you retire, a Roth IRA may serve you best because it will allow your contributions to be taxed at your current income tax, which is at a lower tax bracket than what it will be in the future.
The opposite is true for a person who does not expect their salary bracket to change much in the future.
Being taxed on their withdrawals using a traditional IRA will allow them to grow their portfolio much faster while they are still working.
The amount of money you are taxed, and when these taxes are deducted from your account will play a huge role in the growth of your retirement account.
All the different types of IRAs that have been discussed in this article come with their own unique tax implications.
However, understanding how to manage these taxes may be complicated for some account holders. As such, it is always a good idea to approach a financial advisor who can explain how paying taxes at a particular time will be beneficial to the retirement account.
Contribution Caps and Deadlines
Since these are tax-advantaged investment accounts, the IRS has to impose strict rules on how much an account holder is allowed to contribute to their portfolio.
Otherwise, without contribution caps in place, high-income earners would take advantage of their IRA to make huge deposits that would be tax-free.
In 2024, the contribution limit for a traditional IRA or Roth IRA is set at $7,000, with an additional $1,000 being allowed as a catch-up contribution for those who are aged 50 or older.
Similarly, there are also contribution deadlines in place that govern when deposits should be made. If you are planning on opening a traditional IRA or Roth IRA in 2024, you will have until the 15th of April, 2025 to make your contributions.
If you miss the deadline or exceed the contribution limit set by the IRS, you risk incurring tax penalties that may eat up a huge chunk of your savings.
Withdrawal Norms and Penalties
Various withdrawal rules and penalties also apply to each type of IRA that you can go for.
If, for example, you have your money saved in a Savings Incentive Match Plan for Employees (SIMPLE IRA) or Simplified Employee Pension (SEP IRA), you can take distributions from your account at any time.
However, your withdrawals may come with a 10% additional tax if you do not meet the minimum retirement age.
With a Roth IRA, as long as you meet the five-year holding plan for all contributions made to the account, you can withdraw tax-free distributions from your retirement funds.
Conducting an IRA rollover from an existing retirement account is the best way to fund any type of IRA that you wish to open.
Besides being handled mostly by your current and incoming custodians, there are also many tax advantages that a rollover brings.
The most important thing to understand is that the IRS does not consider a rollover as distributions. As such, any money you remove from, for example, your 401(K) account, will not be taxed as long as you conduct the rollover according to the IRS rules and regulations.
Consider the following rollover rules:
- You are allowed one rollover only per year.
- A 10% penalty applies to account holders who fail to re-contribute their rollover and are below the age of 59 1/2.
- All the money that is rolled over from your 401(K) must be removed from your bank account and deposited into your new IRA account within 60 days.
Comparing Different IRA Options
Once you have a general understanding of how each of these types of IRA accounts works, it will be time to narrow down your options to just two or three IRAs and choose the best one. It helps to consider the following comparisons between common IRAs:
Traditional IRA Vs. Roth IRA
As we compare Roth and traditional IRA, we see that their differences are in paying taxes upon contribution or upon withdrawal. With a traditional IRA, you contribute pre-tax dollars and your money grows tax-deferred. Only when you decide to make withdrawals, will you be taxed according to your current income tax bracket.
Holders of Roth IRA accounts contribute after-tax dollars to their portfolio and their funds will grow tax-free because they have already been taxed when they made the deposit.
When they are ready to make withdrawals after a five-year holding period, they will do so without the need to pay any taxes.
A Roth IRA is the better option for those who think they will be in a higher tax bracket when they retire. This is because they can pay taxes at a much lower rate when contributions are made.
SEP IRA Vs. SIMPLE IRA
Both SEP and SIMPLE IRA plans are designed for the benefit of small business owners and their employees.
However, with a Savings Incentive Match Plan for Employees IRA, both employer and employee contributions are made to the account, which allows it to grow much faster than a SEP IRA which only allows employer contributions.
Traditional IRA Vs. Rollover IRA
The only major difference between a traditional IRA and a rollover IRA is the source of funds that were used to open the account.
A rollover IRA gets all its funds from an existing retirement plan, such as a 401(K), while a traditional IRA can be funded by other means, such as a direct transfer from a bank or other financial institution.
Roth IRA Vs. Backdoor IRA
With a Roth IRA, the account holder needs to meet the required income limits before being allowed to contribute their after-tax dollars to the retirement plan.
However, a backdoor IRA provides an option to sidestep these IRS rules and allow individuals with high salaries to contribute to their Roth IRA after their deposits have been taxed.
IRA Vs. Other Retirement Accounts
Any type of IRA account, whether it’s a Simplified Employee Pension or Roth IRA differs from other retirement accounts when it comes to the contribution limits, required minimum distributions, and other IRS rules on withdrawals.
Typically, IRA contributions are not as high as those of other commonly known retirement plans, such as 401(K) accounts.
However, instead of being forced to invest your funds in a handful of assets, an IRA usually gives the account holder a lot more freedom when understanding IRA and choosing their investment choices.
IRA Vs. 401(K): A Comparative Analysis
One of the most common comparisons that are made by individuals planning their retirement is that of IRAs and 401(K) plans.
The most obvious difference is that a 401(K) has much higher contribution limits than an IRA. In 2024, a 401(K) account holder is allowed to contribute up to $23,000, which is much higher than the $7,000 allowed for traditional and Roth IRAs.
However, even though your portfolio will not grow faster than a 401(K) if you work for a small business or are self-employed, you may not have a choice but to simply opt for an IRA.
The only solace you can get is that your self-directed IRA will allow you to invest in a wider range of assets.
IRA Vs. Pension: Key Differences and Similarities
A pension is an example of an employer-sponsored plan, which means it is the business owners who are responsible for setting it up for their employees.
Both the employer and employee can make contributions to their pension, whereas this is not always the case with an IRA.
The similarity between the two is that they are both common ways of planning for retirement. When handled properly, employees and self-employed individuals can ensure that their financial futures are secure using either Roth IRAs or pension plans.
IRA Vs. Social Security: Understanding the Distinctions
Roth IRAs and other types of individual retirement account plans are specifically designed for the benefit of self-employed individuals.
Social security, on the other hand, is a government-guaranteed basic income that can be used by older Americans.
The money used for this is funded by taxes paid by employees and their employers. A social security number is required to access the funds in this case.
Making the Right IRA Choice
The importance of making the right IRA choice is often overlooked. However, the wrong choice between, for example, a Roth IRA and a traditional IRA can have lasting effects on your retirement savings portfolio.
Factors to Consider When Choosing an IRA
The following are some of the factors that you need to consider when choosing the best type of IRA for your needs:
- Tax benefits of each type of IRA
- Contribution limits and minimum distributions
- The number of years left until retirement
- Predicted salary bracket upon retirement
- Employed versus self-employed individuals
- Financial goals
- Individual circumstances
Importance of Financial Advisors in IRA Selection
It is easy to get confused by all the financial terms and IRS rules that you will come across when planning for your retirement.
You can easily forget important information that will impact the growth of your retirement savings or result in you being penalized by the IRS.
As such, consulting financial advisors is very important when selecting your IRA. These can be from banks, brokerages, or other types of financial institutions.
Although the temptation to save a little money by not hiring a financial advisor will be there, you need to consider the consequences of being stuck in the wrong type of long-term savings plan with no way to get out without incurring serious tax penalties.
Even though it is possible to convert some types of IRA accounts into others, it often comes at a cost. As such, it is better to take the time to talk to a financial advisor before making your decision.
The Role of Tax Professionals in IRA Decisions
One area where you can easily slip up when managing your Roth IRAs or other types of IRA accounts is when it comes to paying taxes.
Roth IRAs, for example, are taxed when making distributions, and traditional IRA contributions are made with after-tax dollars.
Inherited IRA distributions may not be taxed while the same is not true for traditional IRAs. Many more such rules exist for SIMPLE IRAs, SEP IRAs, etc.
As such, you may need to hire a tax professional to look at your retirement plan and help you pay the right amount of taxes at the required time.
Setting up an IRA
It is easy to set up your IRA if you do your research and partner with the right IRA custodian for your needs.
They will oversee the IRA rollover and investment of your IRA funds into the assets of your choice.
Steps to Open an IRA
If you are planning on opening a traditional or Roth IRA in 2024, take the following steps:
- Decide between robo advisors or online brokers.
- Choose the right IRA custodian.
- Open your account.
- Fund the IRA using a rollover or direct transfer.
- Start making annual IRA contributions to your retirement plan.
- Choose the assets you wish to invest in through your traditional and Roth IRAs.
Choosing the Right Financial Institution
In the hands of the right financial institution, your traditional and Roth IRA contributions can quickly add up to a respectable retirement portfolio that will take good care of you in your twilight years.
However, not all IRA custodians are reliable or capable when it comes to meeting your needs. A tax-advantaged investment account is only beneficial if it is managed properly.
The custodian you choose will be responsible for one of your most important long-term investments, so you need to make sure that your retirement plan is in the hands of the right financial institution.
Role of IRA Custodians
What does an IRA custodian do? Well, in most cases, the role of an IRA custodian can be summarized by the following:
- Open the IRA accounts.
- Conduct a rollover from an existing retirement plan.
- Ensure the account meets the standards set by the IRS.
- Manage the IRA.
- Execute investment decisions.
Managing Your IRA Investments
You have to be very careful how you manage your IRA investments. Market volatility can have a huge impact on stocks, bonds, and mutual funds.
This is why, as an IRA account holder, you need to consider exploring other options regarding where you choose to invest your funds.
This is where Roth and traditional IRAs can be better options than a 401(K).
After making your contributions, you can diversify your retirement account by investing in real estate, gold, private companies, or a wide range of other types of investments.
Frequently Asked Questions
What Is the Difference Between a Traditional IRA and a Roth IRA?
Traditional IRAs are funded through pre-tax dollars, while Roth IRA contributions are made after paying your taxes at the current rate of your income tax bracket.
This is the major difference between the two and can have a huge impact on how much funds you have available in your retirement account when you retire.
Can I Have More Than One Type of IRA?
There is no specific IRS rule that limits the number of IRAs that you can have. This means it is allowed to have a selection of Roth and traditional IRAs as part of your retirement portfolio.
However, you have to take care not to exceed the annual contribution limits set by the IRS across all your accounts.
In 2024, the annual contribution limits for traditional and Roth IRAs are set at $7,000. This means the total amount of money you can contribute to all your IRAs cannot exceed this amount without any penalties.
What Are the Tax Implications of Withdrawing From an IRA Before Retirement Age?
Withdrawals made from an IRA account prior to age 59½ are penalized as early withdrawals by the IRS. These distributions will be considered as gross income when being taxed and are subject to a 10% penalty.
However, various exceptions do exist that may allow you to make penalty-free withdrawals from your IRA even before reaching retirement age.
A good example is when you make withdrawals to pay your medical insurance premium after becoming unemployed.
How Does a Rollover IRA Work?
A rollover IRA involves transferring funds from an existing retirement plan, such as a 401(K), to your new IRA account. Your custodian will contact your current retirement plan manager and request the funds on your behalf.
Once the funds are deposited into your account, you will have 60 days to move them into the new IRA or risk being penalized.
What Is the Maximum Amount I Can Contribute to an IRA in a Year?
The contribution limit for an IRA is adjusted by the IRS every year, so you will have to check on their website before making deposits. In 2024, the contribution limit for a traditional IRA or Roth IRA is $7,000.
Understanding the various types of IRA accounts that are available is a very important step in your retirement plans. Many features and tax implications are unique to each type of IRA that will greatly affect the growth of your account.
If you want to start 2024 the right way by investing in a suitable and reliable IRA, consult an experienced financial advisor before you make any solid long-term decisions.