1/20/2023
IRA accounts can be a very helpful financial instrument for those who have a good retirement plan in mind. For many people in the U.S., retirement is most often associated with the 401(k).
However, 33% of the workforce does not have access to this benefit, having to save on their own for this purpose.
What do we call an IRA?
The acronym IRA stands for: Individual Retirement Account. In it, you can make tax-free contributions to have a fund at the time you opt for retirement. These tax benefits vary according to the scheme you choose and we will detail this later.
When you select an IRA, you have the opportunity to invest in whatever suits you best. You can say that their tax advantages are a way for the government to help you and, at the same time, incentivize you to save for your golden years.
Even if you have been included in a 401(k) and have earned income, you can open one of these savings accounts.
Types of Individual Retirement Accounts
The list of IRA accounts is not extensive, but their operation can be somewhat complicated. We hope to clarify that for you by describing each one:
SEP-IRA
Also known as Simplified Employee Pension, they can be established by self-employed or small business owners. These are the only people who can make contributions, which are deductible for the current year.
The limit established as annual contribution stands at 25% of labor compensation. In addition, there is no income limit to contribute to a SEP-IRA account.
Simple IRA
This account is not very different from the previous one and can be constituted by both employers and self-employed. The difference is that both can make contributions.
It also has no income limitations and employees can contribute up to $14,000 in 2022 and up to $15,500 in 2023. And if the plan allows, those over 50 can make catch-up contributions of up to $3,000.
Traditional IRA
This account allows you to invest pre-tax income. That is, your contributions may be tax-deductible and the corresponding taxes are deferred until you withdraw the accumulated money.
Although anyone can contribute to this type of account regardless of income, there are certain restrictions. If you are age 50 or older, you can deduct up to $7,500 in 2023 and up to $7,000 in fiscal year 2022.
Contributions are tax deductible if you or your spouse does not have a workplace retirement plan. On the other hand, eligibility for this tax break will expire for higher earners. For example, in 2022, those ineligible were:
- An applicant with household income of $78,000.
- Joint and married applicants with an occupational retirement plan and income of $129,000.
- Joint and married applicants with income of $214,000 and one has a work retirement plan.
For 2023, ineligibility for deductions now stands as follows:
- One applicant with household income of $83,000.
- Joint and married applicants with an occupational retirement plan and income of $136,000
- Joint and married applicants with household income of $228,000 and one has a workplace retirement plan
Roth IRA
Unlike the traditional IRA, this type of IRA receives contributions that have already been taxed. This means that the deposits cannot be deducted during the year in which they were made. However, this money grows tax-free for when you want to withdraw it.
The major difference from the traditional IRA is that there are income restrictions on who can contribute.
Advantages and disadvantages of IRAs
To summarize, we can state the pros of IRAs as follows:
- Many financial institutions allow you to open an IRA with a minimum balance and no fees.
- There is no need for an employer to do this process for you and you can use the account to supplement your 401(k).
- Your contributions can be taxable or tax-free, at your convenience.
- You have a wider variety of assets to invest your funds in, such as brokerage firms, banks or robo-advisors.
When choosing an Individual Retirement Account, consider the cons:
- You must be in charge of the process, choosing the institution and the investment assets.
- If you withdraw money from a traditional account before you turn 59 ½, you receive a 10% penalty.
- Whether it's a Roth or traditional, you must make contributions and report them to the IRS (traditional only).
Like IRAs, there are many banking products that make your life easier and you can learn about them in more detail at Busconómico.
Español: Qué son las cuentas IRA o Cuentas Personales para el Retiro