This article discusses the types of Individual Retirement Accounts available and who qualifies for each. It also discusses the limits, tax advantages and other rules the IRS imposes on these accounts.
Types - Traditional IRA
There are four primary types of Individual Retirement Accounts in use today: Traditional IRA, Roth IRA, SEP IRA and SIMPLE IRA. A Traditional IRA is a pre-tax IRA. You will receive a tax deduction for the amount contributed up to $5,000 unless you are age 50 or older, in which the limit is $6,000. (2009 limits are quoted here; future years will be indexed to inflation.) The amount that is tax deductible is reduced if you are an active participant in a 401(k) plan. However, taxes must be paid on both contributions and earnings when distributions are paid from the account. There is a 10 percent penalty for withdrawals made before age 59 1/2, and mandatory withdrawals must begin no later than age 70 1/2. You must have earned income to contribute to an IRA.
Types - Roth IRA
A Roth IRA is an after-tax IRA. You will contribute after-tax dollars to the account, with the same limits as a Traditional IRA, but if you meet certain conditions, all of the funds, including earnings, can be withdrawn tax-fee. There is no requirement to begin distributions at 70 1/2. However, there are income limits that don't exist in a traditional IRA. If you make over $120,000 in 2009, you cannot contribute. If you make between $105,000 and $120,000, you can contribute between $0 and $6,000. (There is IRS tax guidance on limits in this range.) If you make less than $105,000, you can contribute up to $5,000 if under age 50 and $6,000 if over.
Types - SEP IRA
An SEP IRA is a Simplified Employee Pension and is designed for self-employed business owners. It allows saving for retirement without the hassle of a 401(k) or other qualified retirement plan. Individuals who are not self-employed should not consider this option.
Types - SIMPLE IRA
A SIMPLE IRA is a retirement program for small businesses. Your employer would typically establish the account for you and offer you the option to contribute from your paycheck. If you work for a small business and don't have a retirement plan, you may consider inquiring with your employer.
Each of the four IRA types were created to cover different types of workers, from small-business owners to the everyday employee saving for retirement. Today, most people can choose between a Roth and a Traditional IRA. Individuals looking to establish an IRA often inquire about the SEP IRA and "SIMPLE IRA. Think of these more as retirement plans, similar to 401(k)s, that require a business to establish, even though they have the IRA name.