IRAs for Beginners

What is an IRA?

An individual retirement account, IRA for short, allows you to save money for retirement in a tax-advantaged way.

An IRA is an account set up at a financial institution that allows the account owner to save for retirement with tax-free growth on a tax-deferred basis. There are five main types of IRAs, each with their own advantages:

• Traditional IRA
• Roth IRA
• SEP IRA
• SIMPLE IRA
• Rollover IRA

Traditional IRA

A traditional IRA is an account to which you make contributions with money you may be able to deduct on your tax return, and any earnings can potentially grow tax-deferred until you withdraw them in retirement.

Many retirees find themselves in a lower tax bracket than they were in their accumulation years, so the tax-deferral means the money may be taxed at a lower rate.

Roth IRA

A Roth IRA is an account to which you make contributions with money you’ve already paid taxes on, and your money may potentially grow tax-free, with tax-free withdrawals in retirement, provided that certain conditions are met.

Related: Uses of a Roth IRA

SEP IRA

A SEP IRAs is an account option for the self-employed or small business owners. It has higher contribution and income limits. Similar to traditional IRAs, the contributions are tax-deductible and investments grow tax-deferred until retirement, when distributions are taxed as income.

In 2023, contributions are limited to 25% of compensation or $66,000, whichever is less – much more than what workers alone can set aside in a regular IRA. SEP IRAs require proportional contributions for each eligible employee if business owners contribute for themselves.

SIMPLE IRA

A SIMPLE IRA is another type of employer-sponsored retirement plan for the self-employed or business owners with fewer than 100 employees. Employees can defer their salary to their account. Similar to traditional IRAs, the contributions are tax-deductible and investments grow tax-deferred until retirement, when distributions are taxed as income.

In 2023, employee contributions are limited to $15,000 per year for those under age 50. People age 50 and older can make an additional $3,500 catch-up contribution in 2023. Employer contributions are mandatory.

Rollover IRA

A rollover IRA is a type of IRA account that allows you to transfer eligible assets from an employer sponsored plan, such as a 401k, into an IRA. People tend to utilize a rollover IRA when they’re switching jobs so they can house all of their money in one account.

IRA Contribution Limits in 2023

The government places limits on the amount you can contribute to all of your IRA accounts, which typically changes every few years based on inflation. 

Both traditional and Roth IRAs have the same contribution limits: $6,500 in 2023, plus an additional $1,000 if you are age 50 or older. That is a combined limit – so, if you have both a traditional IRA and a Roth IRA, you can only contribute a combined $6,500 this year.

But, before you think about maximizing your IRA contributions, you need to make sure that your annual earnings fall within the government’s threshold. Your deduction capability begins to phase out as your income increases. The limits vary, based on your tax filing status, so check the IRS’ updated guidelines to determine your eligibility.

Why Should You Invest in an IRA?

It’s estimated that you may need up to 85% of your pre-retirement income in retirement. An employee-sponsored retirement plan, such as a 401k, might not be enough to accumulate the savings you’ll require later in life. That’s why many individuals utilize a combination of a 401k and an IRA.

An IRA can help you:

• Supplement your current savings in your employer-sponsored retirement plan.
• Gain access to a potentially wider range of investment choices than your employer-sponsored plan.
• Take advantage of potential tax-deferred or tax-free growth.

Related: 4 Reasons Your Retirement Plan Might Fall Short

Our team of advisors can help you determine which IRA type is best for your individual needs, as well as get the account set up for you. If you’re interested in learning more, you’re welcome to schedule a complimentary consultation below.