Individual Retirement Accounts (IRAs) are retirement savings accounts that provide special tax advantages not available for other types of savings accounts. IRAs vary based on types of contributions, tax advantages, income requirements and limits, and age limits for contributions and withdrawals, but the main difference is when you pay income taxes on the money. The three most popular types are Traditional, Roth and Simplified Employee Pension (SEP) IRAs.
Traditional and SEP IRAs allow tax deductions for contributions, while Roth IRAs allow you to withdraw your money in retirement tax-free. With traditional and SEP IRAs, you pay taxes when you withdraw money from the retirement plan. With a Roth IRA, you pay taxes at the time you contribute, but the eventual distribution is tax-free, as long as you meet certain requirements. Here's a more in-depth look at how these three IRAs compare.
Putting money in: Contributions to a traditional IRA may be tax-deductible in the year you make them, depending on your income and participation in an employer-sponsored retirement plan, such as a 401(k). You can continue to contribute to these accounts as long as you have earned income (a paycheck).
Tax-deferred savings: Your contributions and earnings grow tax-deferred, which means you won’t pay income taxes until you withdraw money from the account. Even if you aren’t eligible for a tax deduction, your savings will still be tax-deferred.
Taking money out: You’ll need to begin withdrawing money (usually 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.
Putting money in: With a Roth IRA, your contributions aren’t tax-deductible. Contributions can be made as long as you have earned income.
Tax-deferred savings: Roth IRAs allow for tax-free growth over your lifetime.
Taking money out: Withdrawals are tax-free, subject to certain requirements:
- You’re at least age 59½.
- You’ve had your account for at least five years.
You can still make withdrawals if you don’t meet these requirements, but you may pay taxes and/or penalties.
Simplified Employee Pension (SEP) IRA
Putting money in: SEPs allow self-employed individuals and businesses to contribute to a retirement plan for themselves/their employees. These plans allow both employers and employees to contribute to the account subject to certain restrictions, and contributions are tax-deductible for the employer. Contribution limits are higher for SEP IRAs—a maximum of 25 percent of the employee’s income (up to $58,000).
Tax-deferred savings: Contributions and earnings grow tax-deferred until withdrawn.
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 an SEP at any time without having to show a hardship, but you may be subject to taxes and a 10% tax penalty.
Ready to start saving, but still want to know more? Navy Federal Credit Union offers more information on retirement accounts like savings rate comparisons, simple explanations on consolidating if you have more than one IRA and more. Explore your retirement savings options to build the retirement you want.
|Traditional IRA||Roth IRA||SEP IRA|
|Potential Tax Write-Off||Yes||No||Yes|
|Tax-Free Earnings Growth||No||Yes||No|
|Maximum Annual Contribution1||$6,000 under age 50, $7,000 age 50+||$6,000 under age 50, $7,000 age 50+||25% annual compensation, not to exceed $58,000|
|Adjusted Gross Income Eligibility||Almost everyone with earned income (some exceptions)||
Individuals earning <$125K
$125,000-$140,000: allowable contribution reduced.
Married filing jointly: Those earning <$198,000
|Everyone with self-employed earned income (some exceptions)|
|Maximum Age to Make Contributions||No maximum while earning a paycheck||No maximum while earning a paycheck||No maximum|
|Non-Wage-Earning Spousal Contributions||Same as wage earner||Same as wage earner||Same as wage earner|
|Tax Deductibility of Contributions||Up to 100%, depending on modified adjusted gross income and participation in employer-sponsored pension plan||Cannot deduct contributions||May be tax deductible, based on specific rules|
|Tax Treatment of Dividend Earnings||Grows tax-deferred until withdrawn||Grows tax-free||Grows tax-deferred until withdrawn|
|Taxes Upon Withdrawal||Non-deductible contributions received tax-free; earnings and deductible contributions taxed at ordinary income tax rate||None, as long as withdrawal is a qualified distribution||Non-deductible contributions received tax-free; earnings and deductible contributions taxed at ordinary income tax rate when withdrawn|
|Withdrawal Restrictions||Most made before age 59½ result in IRS penalties
|Penalty-free withdrawal after age 59½ provided money has been in account at least 5 years
Penalty-free and tax-free withdrawals prior to age 59½ if the funds are used for:
|Most made before age 59½ result in IRS penalties
|Age at Which Withdrawals Must Begin||72||None||72|
1The maximum can be contributed to a Traditional, Roth or SEP IRA, or split between all three.