Table of Contents
Types of Bank Investments
Certificate of Deposit
Types of IRAs
401k Plans
Types of Bond Investments
Fixed Income Investing
Navigate This Post
IRA
Traditional IRA
Roth IRA
Self Directed IRA
SEP IRA
Simple IRA
The Employee Retirement Income Security Act (ERISA) enacted in 1974 brought the Individual Retirement Account or IRA into being. With the IRA, employees have the option of making structured payments into this account for the purpose of retirement planning. Tax benefits on the IRA payments make them doubly attractive.
Employers can match the employee contributions into the IRA, boosting the individual’s savings for the future. This also serves as an incentive for the employee of the company. Every tax paying American citizen under the age of 70 ½ can create an IRA and contribute to it. The FDIC insures IRAs, which makes them safe investment options.
There are several types of IRAs, which offer some unique features and benefits to the account holders.
A traditional IRA is for anyone who can make and maintain minimum contributions. It is maintained at an institution such as a bank and the funds may be invested in instruments that are approved by the government. Typically, only those investments, which are considered safe are approved for the IRAs, because the money from the account is aimed at retirement planning.
Traditional IRAs offer significant tax benefits. The taxation applies only at the time of withdrawal. Considering that you are likely to require the IRA funds only post retirement when your lack of salaried income puts you in a lower tax slab, this is a huge advantage.
The contributions are deducted from your gross income before you calculate the total tax you need to pay on your income. Net result is that you pay taxes on a lower income. This feature makes the traditional IRA the most favored IRA account in the US.
Investors can withdraw funds from the traditional IRA after the age of 59 ½. This is subject to the stipulation that the IRA has been in operation for at least 5 years. Else you will have to wait for the 5 years to be completed. Other than in a few exceptional cases, any withdrawal before the age of 59 ½ will draw a 10% penalty in addition to the normal income taxes on the funds.
The working of the Roth IRA is very similar to its traditional cousin. One main difference is that contributions to the Roth IRA are not tax deductible. However, the withdrawals are tax free if the IRA holder fulfills the necessary stipulation of age and the IRA has been in existence for the minimum 5 year period. It is easier to pull out cash from a Roth IRA than a traditional IRA.
It is also important to know that there are no mandatory withdrawals beyond the age of 70 ½ with Roth IRAs. You can continue to contribute to the Roth IRA well beyond this age and until you wish to do so. This means that the Roth is a safe and lucrative investment program during retirement years too, especially for those who do not really depend on the savings from their IRA account to manage living expenses.
Another significant advantage with the Roth IRA is that the funds parked in this investment account can be left to heirs after the account holder’s death. The best part is that this legacy accumulates value tax free. Minimum distribution (withdrawal) rules will be applicable on the heirs though. This feature comes in very handy especially with huge estates where tax would otherwise take a huge bite out of the estate’s total value.
Traditional IRAs can be converted to Roths, but you will have to pay off taxes on the investment being converted. You can also opt for part conversion of your traditional IRA into Roth to control the amount of taxes you will need to pay during the conversion.
As the name suggests, this IRA is primarily managed by you, the owner. However, according to IRS regulations, a custodian is required to be in charge of managing the account and ensuring that all regulations are conformed with. This custodian may also provide you, the IRA owner with advice and help on investing and aid in understanding the government provisions pertaining to these investment options.
Interested investors can open a self directed IRA with a brokerage. Most of them allow you to open this kind of account online with detailed instructions on the process to help you. You can either create a new self directed IRA in this manner or ask for company sponsored retirement funds to be directly credited into this IRA account to avoid taxes when you change jobs or retire.
Self directed IRAs offer much more options in terms of the kind of investments you can undertake with the funds parked here. Although these are also called real estate IRAs by some, property is not the only kind of investment you can make with these funds.
You can truly diversify your retirement saving funds by investing in real estate, mortgages, company equity, stocks and many other investment avenues using this account. There are some restrictions on the kind of investments that can be made. For instance, insurance contracts and collectibles are not approved investments for self directed IRA funds.
A Simplified Employee Pension IRA (SEP IRA) is a kind of savings plan sponsored by the employer. Here the employer makes contributions to the IRA for the benefit of his or her employees. This kind of IRA account can either be opened by the employer for an employee or the employer can contribute to an existing employee IRA. The SEP IRA is also a good option for self employed individuals, who can save with this low cost, low maintenance investment option.
The SEP IRA is subject to the same rules and regulations as the traditional one. This is because most institutions ask for the employee to have a traditional IRA or for one to be opened in the employee’s name, and use this as a SEP account before any contributions can be deposited. Some institutions also insist that the IRA be named a SEP IRA for this purpose.
The employer gets tax benefits from the contribution he makes to this IRA. The funds in the SEP IRA are only taxed at the time of withdrawal by the beneficiary.
The contributions schedule is quite flexible and allows employers to maintain more discretion in how frequently they make deposits into this account. However, regulations do require that all employees are treated equally by means of matching contributions to their individual SEPs.
The Savings Incentive Match Plan for Employees is more commonly known as the SIMPLE IRA. As the name suggests, this is an uncomplicated and hassle free retirement fund that allows employers to provide funds for retirement planning of employees. The SIMPLE IRA is for small businesses, which have less than 100 employees. The administration of the SIMPLE IRA is easy and economical when compared to other retirement plans, which makes it a good option for small businesses.
Contributions can be deducted from the salary of the employee. This means that the employer gains a significant tax advantage when he makes contributions to the employee’s IRA account. Contributions to SIMPLE accounts are also lower than other kinds of IRA accounts.
The employer is required to match the employee contribution or make non elective contributions every year. However, the employee is allowed much more flexibility in deciding his contribution schedule and amount. The funds are taxed at the time of withdrawal only. Premature withdrawals or roll overs may draw a penalty.
Another advantage for employees with a SIMPLE IRA account is that they can choose the institution where the account is held. The investment options for the IRA funds depend largely on the institution where the account exists. Normally there is a wide range of options to choose from. There are also self directed SIMPLE IRAs, which allow market savvy employees to manage their own investment portfolio with the funds parked in the account.