An IRA (Individual Retirement Account) is essentially a type of retirement savings accounts anyone can open. They are mainly beneficial for people who fall into one of several categories:
- Their employer does not have a pension plan or 401K plan.
- They are self-employed.
- They are a small business owner.
There are four different types of IRA accounts, depending upon your exact needs and how you want to save for your retirement. Depending upon the type of IRA, it can work slightly differently, but the primary objective of all types is to ensure a person has funds set aside for when they reach retirement age and have access to supplemental income along with their Social Security.
The two main types of IRAs most people require are either a traditional IRA or a Roth IRA. For small business owners, the other two type of IRAs you can consider are SEP IRAs and SIMPLE IRAs. Let’s take a look now at each of these types and how each one works.
With Roth IRAs, you make contributions from your net post-tax earnings, not pre-tax earnings, like a traditional 401K. The main advantage of a Roth IRA is you already paid taxes on the contributions. Any returns on your investments and interest payments, as long as they are redeposited into the IRA, are tax-free, so long as you do not make any withdrawals prior to reaching retirement age. A Roth IRA is also beneficial for younger people who want to avoid the uncertainty of future tax rates.
Basically, this type of IRA is similar to a 401K, and contributions are made pre-tax. You are charged taxes on interest payments and returns on investments, along with the money you contributed whenever you make a withdrawal after retiring. The main benefit of a traditional IRA is the contributions you make could be tax deductible.
Savings Incentive Match Plan for Employees (SIMPLE) IRAs are similar to traditional IRAs. The only difference is employers are required to make a flat 2% contribution, in cases where employees do not participate in the plan. For employees who do contribute, employers must match the amount contributed up to a maximum of 3%. For small business owners, setting up a SIMPLE IRA is easier than other types of plans, plus they have higher contribution limits than individual Roth and traditional IRAs.
Simplified Employee Pension (SEP) IRAs are also for small business owners and self-employed individuals. Unlike SIMPLE IRAs, only the employer can make contributions toward the plan. However, when the employer elects to make contributions, they must do so for all employees. Just like traditional IRAs, the contributions are not taxed until the money is withdrawn. SEP IRAs also allow for higher contribution limits compared to Roth and traditional IRAs.
To learn more about IRAs and for assistance deciding which one is best for you, visit your nearest branch of The People’s Federal Credit Union or call us at 806-359-8571 today!