Individual Retirement Accounts

IRA: These three important letters could potentially play a huge role in your retirement savings plan. That's because an Individual Retirement Account, or IRA, helps you save for retirement while also protecting you from another set of initials: IRS.

An Individual Retirement Account (IRA) is a type of savings account that provides certain tax benefits. Saving for retirement with tax-free growth or on a tax-deferred basis has many advantages.

If you haven't already included an Individual Retirement Account in your retirement savings plan, you could be missing a great opportunity to save for your retirement dreams and reduce your tax bill.

There are different types of IRAs, each with their own unique set of tax implications and eligibility requirements.

Traditional IRAs

Here are some of the key features of a Traditional IRA:

• A traditional IRA is considered a tax-deferred retirement savings vehicle. This means that you will not have to pay any taxes on your earnings from this account until you withdraw the funds. As a result, you may be able to accumulate more in an IRA compared to taxable accounts because you are able to defer taxes on the interest and dividends earned by your IRA’s investments.
• Anyone under age 70½ with earned income can contribute to a traditional IRA. Your contribution may be tax deductible if you meet certain criteria. The restrictions on who can take a deduction for Traditional IRA contributions are based on both your income and whether you or your spouse are covered by a retirement plan at work.

• When you withdraw the money from the IRA, the distribution is included in your taxable income. It is taxed as ordinary income.
• In general, IRAs should not be accessed prior to retirement. If you withdraw the money before reaching age 59 and a half, there is an additional 10 percent tax on that early distribution. The penalty tax is in addition to federal and state income taxes at your ordinary income tax rate. Some exceptions to the early withdrawal rules exist allowing you to take money from your IRA without penalty if you meet certain criteria.
• It is important to note that an IRA is not an actual investment, but rather a type of an account that may be funded with investments such as stocks, bonds, mutual funds, CDs, or other allowable investments.

With a traditional IRA you must take minimum distributions no later than the year when you turn 70.5 years old. If you do not meet the required minimum distribution each year you will have to pay an excise tax of 50 percent of the required minimum distribution amount.

Roth IRAs

Here are some of the key features of a Roth IRA:

• A Roth IRA is a non-deductible retirement savings vehicle.
• Unlike a Traditional IRA, where the account grows on a tax-deferred basis, A Roth IRA provides potentially tax-free growth of retirement savings and distributions. Distributions from a Roth IRA are completely tax-free, as long as you meet certain conditions. As a result, you may be able to accumulate more in your Roth IRA than in a taxable account because you are not paying tax every year on the interest and dividends earned in your Roth IRA account.
• You can potentially make contributions to a Roth IRA even if you are covered by a retirement plan at work.
• The ability to contribute directly to Roth IRAs is based on income limitations.

• Unlike Traditional IRAs, Roth IRAs are not subject to required minimum distribution rules throughout your lifetime.
• Like a Traditional IRA, it is once again important to note that a Roth IRA is not an actual investment. Instead, it is a type of account that may be funded with stocks, mutual funds, CDs, or other suitable investments.

Choosing Between the Traditional and Roth IRA

Deciding if a Traditional or a Roth IRA makes the most sense for you can be a challenging selection to make. The ultimate deciding factor usually comes down to whether you want to take advantage of the upfront tax break (if you are eligible) or enjoy tax-free withdrawals later. These are both good tax-advantaged account options, but which is better?

If you are trying to choose the best option, consider these deciding factors:

• Estimate how soon you will likely need to access your retirement savings. In general, you must be at least 59 1/2 to begin withdrawing funds from either a traditional or Roth IRA without a penalty. In most situations, you will have to own a Roth IRA for at least five years before you can access it without being taxed on the earnings growth. However, it is important to note that you can always withdraw your original contributions without a penalty at any point in time. If you think you may need the money sooner than five years after you open the account and may need to access your original contribution and earnings, the Traditional IRA may be the best choice. If you have a long-term time frame that is greater than five years, this should not be a factor.

• Determine how much of your contribution you can potentially deduct. If you earn too much to make a tax-deductible contribution to a Traditional IRA but you still qualify for a Roth IRA, then the choice is easy. If you earn too much to contribute directly to a Roth IRA, you may still be able to use Roth IRA conversion rules to make what is sometimes referred to as a Backdoor Roth IRA contribution.
• Review the estimated taxable income level you plan on being at in retirement: If you anticipate remaining in a high (or higher) tax bracket, the tax-free distribution of a Roth IRA may be more appealing.

Non-Deductible IRAs

Even if you can't deduct your Traditional IRA contributions or set aside money in a Roth IRA, you can still save with a non-deductible IRA. Like a Roth IRA, you don't get a deduction for your contributions to a non-deductible IRA. Be aware that there are significant differences in how the distributions are taxed.

• Although your non-deductible IRA contributions will not reduce your taxes in the year you make them, the earnings on them are tax-deferred, a key tax advantage of a regular IRA.

• When you begin taking distributions from a non-deductible IRA, part of the distribution will be a tax-free return of your original, non-deductible contribution, and the remaining amount will be taxed as ordinary income.
• In general, most of the other rules that apply to Traditional IRAs such as required minimum distributions and early withdrawal penalties also apply to non-deductible IRAs.
• The distinguishing difference between a non-deductible IRA and a Traditional IRA is related to the tax treatment of the original contribution.
• Non-deductible IRAs usually make the most sense for people who are already participating in a retirement plan through their employer and they are ineligible to contribute to a deductible Traditional IRA or their income is above the Roth IRA eligibility threshold. The big attraction is the ability to save more for retirement in an account that provides tax-deferred growth of earnings.

IRA Contribution Limits

The total amount that can be contributed to a Traditional IRA and/or a Roth IRA is limited.

• The maximum annual contribution for 2017 is the lesser of $5,500 or 100 percent of earned income.
• Taxpayers age 50 and older can contribute another $1,000 for a total contribution of $6,500.

You may contribute to both types of accounts if you do not exceed the annual contribution limits. For example, you could potentially put $2,750 in a Traditional IRA and $2,750 in a Roth IRA, or split your contributions in any other manner, as long as you don’t exceed the annual limit of $5,500.

IRA contributions are also limited by your qualifying income. For the purposes of determining your eligibility to make an IRA contribution, qualifying income means wages, self-employment income, alimony, and non-taxable combat pay. Therefore, if you have $4,500 in earned income that amount will become your contribution limit. This rule is especially important for parents seeking to make IRA contributions on behalf of their children who may have limited income from part-time work.

The other income limitation is that you won't be able to contribute to a Roth IRA or take a deduction for contributions to a Traditional IRA if you earn too much. The IRS website shows income limits for contributing to Roth and Traditional IRAs.

Deadlines to Contribute to an IRA

IRA contributions can be made at any time throughout the year. They are not limited by the calendar year, but must be made by tax day to count toward your contribution limit for the prior year. As a result, you can make a 2017 IRA contribution as late as April 17, 2018. ​

Where to Open an IRA

Once you have determined that an IRA makes sense for your situation, you need to determine where to open the account. This means selecting an online broker or other account provider. In general, you can open an IRA through most large financial institutions, banks, mutual fund companies or brokerage firms.

You will typically want to search for an IRA account provider who:

• Has no account fees or very low fees.
• Offers a wide selection of no-transaction-fee mutual funds and commission-free exchange traded funds.
• Provides high-quality customer service support and access to unbiased financial education resources, especially if you’re new to investing.
• Has low account minimums and fund minimums.

How to Fund Your IRA

Every IRA provider has their own unique account setup process. Some IRA providers allow for the ease of online account registration. A few of the key steps involved include establishing a method of funding your account (check, electronic transfers from your bank account, rollover, etc.) and naming beneficiaries for your account.

How Should I Invest the Money in an IRA?

IRAs allow for the investment in a variety of different options. Some examples of allowable investments include the following: individual stocks, bonds, mutual funds, exchange-traded funds, annuities, and certain types of real estate holdings. The type of investments and overall asset allocation mix that is right for you depends on your risk tolerance and time horizon. You can choose an “all-in-one” investment fund (e.g., target date retirement fund) that takes care of your asset allocation for you or customize your portfolio if you are a more hands-on investor.

Individual Retirement Accounts for Small Business Owners and the Self-Employed

While self-employment has many advantages, it can be a challenge to save enough for retirement. If you work as an independent contractor, have any self-employment income, or run a small business you may be eligible for other types of Individual Retirement Accounts. The Simplified Employee Pension, more commonly known as a SEP-IRA, and the SIMPLE IRA are the other types of IRAs to pay attention to if you are your own boss (even if it’s only a part-time gig).

Simplified Employee Pension (SEP-IRA): A SEP IRA is a retirement plan that an employer or self-employed individuals can establish. The employer receives a tax deduction for contributions made to the SEP plan and makes contributions to each eligible employee's SEP IRA on a discretionary basis. The key advantage of the SEP-IRA is the high annual maximum contribution limit, which at $54,000 in 2017 is much higher than the $5,500 cap associated with a Traditional or Roth IRA.

Savings Incentive Match Plan for Employees (SIMPLE IRA): A SIMPLE IRA is an employer-sponsored retirement plan offered within small businesses that have 100 or ​less employees. Small businesses may favor SIMPLE IRAs because they are a less expensive and less complicated alternative to a 401(k) plan. These plans have specific rules on employer matching incentives which are built into the plan. In 2017, employees can generally contribute $12,500 to a SIMPLE IRA. The catch-up contribution limit for 2017 is $3,000 making the SIMPLE IRA contribution limit $15,500 for participants age 50 or older.