Finding Your Way through the IRA Maze
You’re certainly not alone if the words Individual Retirement Account (IRA) cause your mind to spin in confusion. The original IRAs were mind-boggling enough. However, now you have several options, including what many have called the “American Dream” IRA—the Roth IRA. Let’s take a moment and ferret out some of the nuances on the IRA landscape.
Nondeductible IRA. This is the “plain vanilla” IRA. You simply write a check for up to $5,500 per year and you’re in. Your contributions are nondeductible, but the account earnings are tax-deferred. If you need money before age 59½, you pay a penalty tax, except for first-time home purchases (up to $10,000); disability; medical expenses exceeding 10% of your adjusted gross income (AGI); and qualified higher education expenses. Likewise, at age 70½, contributions cease and mandatory minimum withdrawals must begin. While you are not taxed on the money contributed (that has already been taxed), your accumulated earnings are taxed as ordinary income upon withdrawal.
Deductible IRA. Contributions to these IRAs are tax deductible up to $5,500 annually. However, if you or your spouse are active participants in a retirement plan or exceed certain income levels, your contribution may be restricted. As with the nondeductible IRA, your earnings are tax deferred, but because both contributions and accumulations have never been taxed, all withdrawals from your IRA are taxed as ordinary income. Also, the penalties for early withdrawals and the itemized exceptions are the same as nondeductible IRAs. Likewise, mandatory minimum withdrawals must commence at age 70½.
Roth IRA. While the maximum nondeductible contribution remains at $5,500 per person, the Roth IRA has other potential advantages over existing IRAs. Generally, the adjusted gross income limit for single and joint filers is more than double for that of traditional IRAs. In addition, distributions of earnings are tax free, if you’ve maintained your account at least 5 years and are older than age 59½. Under appropriate circumstances, you may withdraw your contributions without penalty and income taxation prior to age 59½. Another advantage is contributions may be made for life and no withdrawals have to be made until one year following the death of the participant.
SIMPLE IRA. For small businesses, many have found the popular 401(k) plan costly to administer. A less costly alternative may be the Savings Incentive Match Plan for Employees (SIMPLE). A SIMPLE IRA may provide immediate vesting and an employer can match employee annual contributions (up to $12,500 for 2015) on a percentage basis (with limitations). There are no annual tax filing requirements and no need for anti-discrimination tests. Simply put, SIMPLE IRAs are less expensive to administer. In addition, both owners and employees can put away more than they could with a regular IRA.
SEP IRA. The Simplified Employee Pension (SEP) shares similarities with an Individual Retirement Account (IRA) and a 401(k) plan, in that the plan is simple to administer and allows both employers and employees to contribute. Congress created the SEP primarily so small businesses could provide a retirement plan without burdensome administrative costs or government paperwork. Contributions to a SEP are similar to a 401(k)—25% or a maximum of $53,000 (for 2015) of earned income annually. As a result, a SEP IRA may allow higher levels of contributions than any other IRA plan.
In a world where many clamor for tax simplification, you may find that retirement planning is also complex. Therefore, an IRA may prove even more attractive for its versatility and ease of implementation. Because Congress has provided many options for individuals and small businesses to install retirement plans, you may find the “right” Individual Retirement Account to fulfill your objectives.
If you would like to take a closer look at what type of IRA fits your objectives and needs, consult a qualified financial professional at Barnes Capital Group for additional information.