Individual Retirement Accounts (IRAs) are retirement savings accounts offered by credit unions, brokerages and other financial institutions. IRA accounts have special tax advantages not allowed for other types of savings accounts. The 3 most popular types of IRAs are Traditional, Roth and Simplified Employee Pension (SEP) IRAs. They have different tax advantages and income and age limits for contributions and withdrawals, but the main difference is when you pay income taxes on the money.
Points to Know
What’s a Traditional IRA?
It’s a special account that allows you to set aside pre-tax dollars for retirement. Benefits: The money in your traditional IRA will grow tax-deferred, which means you won’t pay taxes until you take a distribution (make a withdrawal). Then, your withdrawals will be taxed at your current income tax rate. In addition, depending on your filing status and income, your contributions may be fully or partially tax-deductible in the year you make them.
What’s a Roth IRA?
A Roth IRA allows you to set up a retirement fund with after-tax dollars. Benefits: The money in your fund grows tax-free, and although contributions aren’t tax deductible, you won’t pay income taxes when you take your qualified distributions (withdrawals) if you satisfy the requirements. Plus, unlike other types of IRAs, you aren’t required to make withdrawals (until the death of the owner).
What’s a Simplified Employee Pension (SEP) IRA?
A SEP is a retirement account business owners set up for themselves and for their employees. Benefits: According to the Internal Revenue Service, SEP IRAs follow the same rules for investment, distribution and rollovers as traditional IRAs. However, only employers make contributions. These contributions are tax deductible for employers, and employees won’t pay taxes until they make withdrawals.
How Traditional IRAs Work
Putting money in: Tax deductibility not only depends on your income, but also whether you also have an employer-sponsored retirement plan, like a 401(k). You can continue to contribute to these accounts as long as you have earned income (a paycheck).
Taking money out: You’ll need to begin withdrawing money (referred to as required minimum distributions) by age 72. The money will be taxed at your income tax rate at the time you withdraw it.
How Roth IRAs Work
Putting money in: Although your contributions aren’t tax deductible, you can continue to add them to your Roth, as long as you have earned income (even after age 70½).
Taking money out: Withdrawals are tax-free, but subject to certain requirements:
- You’re at least age 59½.
- You’ve had your account for at least 5 years.
You can still make withdrawals if you don’t meet these requirements, but you may pay taxes and/or withdrawal penalties.
How Simplified Employee Pension IRAs Work
Taking money out: Your funds are taxed at your regular income tax rate when they’re withdrawn. Unlike other types of retirement accounts, you can withdraw money from a SEP at any time without having to show a hardship, but you may still be subject to taxes and a 10% early withdrawal penalty, unless you can qualify for an exception.
What All IRAs Have in Common
While there are important differences among the various IRAs, they share some common features. Knowing these features will make it easier to plan your investment strategy.
- All IRA accounts allow for a wide range of investment opportunities. Investment choices include stocks, mutual funds and exchange-traded funds (ETFs), and annuities.
- Some investments aren’t allowed in IRAs, including certain insurance products (life insurance) and collectibles like art or antiques (your tax advisor can explain the details). When deciding on investments, you should ask whether you’ll have to pay account fees and transaction fees.
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Ready to start saving toward your retirement goals, but still want to know more? Explore Navy Federal’s resources on topics like current rates, retirement savings options and investment options, how to combine more than one IRA and rollover accounts so you can build the retirement you want.
1The maximum that can be contributed to a Traditional, Roth or SEP IRA, or split between all three.
This content is intended to provide general information and shouldn't be considered legal, tax or financial advice. It's always a good idea to consult a tax or financial advisor for specific information on how certain laws apply to your situation and about your individual financial situation.