Understanding IRAs: Types and Rules Explained by Builders Legacy Advance Investment Education Foundation

How many types of IRAs are there and what are their rules?

Traditional IRA:

Traditional IRAs offer tax-deductible contributions, meaning you can reduce your taxable income for the year you contribute. The earnings in your Traditional IRA grow tax-deferred until you withdraw them in retirement. Withdrawals are taxed as ordinary income. You must start taking required minimum distributions from a Traditional IRA by age 72. If you withdraw funds before age 59½, you may face a 10% early withdrawal penalty.

Roth IRA:

Roth IRAs allow you to make non-deductible contributions, but your withdrawals in retirement are tax-free. To qualify for tax-free and penalty-free withdrawals, you must meet certain conditions, such as holding the Roth IRA account for at least five years and being at least 59½ years old.

SEP IRA:

A SEP IRA (Simplified Employee Pension) is set up by employers, often small businesses. Employers make direct contributions to individual retirement accounts for each employee.

SIMPLE IRA:

A SIMPLE IRA (Savings Incentive Match Plan for Employees) is a retirement plan set up by employers, typically small businesses, to match employee contributions. Employees can choose to make salary reduction contributions, and employers are required to make either matching contributions or non-elective contributions.

Bonus tips: here are some factors to consider when choosing an IRA:

Your tax bracket: If you’re in a higher tax bracket, a Traditional IRA might benefit you more because you can deduct your contributions from your taxable income. If you’re in a lower tax bracket, a Roth IRA might be more advantageous since your withdrawals in retirement will be tax-free.

Your age: If you’re younger, you have more time to grow your investments, so you might be comfortable with a higher-risk investment strategy. If you’re older, you might need to focus on more conservative investments to protect your savings.

Your retirement goals: How much do you want to save for retirement? What lifestyle do you envision for yourself? Understanding your retirement goals will help you determine how much to contribute to your IRA and how to allocate your investments