As the age of retirement approaches it is essential to note that social security income of any sort may not be enough for us to comfortably rely on. Therefore, taking advantage of other retirement options is truly necessary. These include Individual Retirement Accounts (IRA), and though there are several types, each option must be assessed based on the individual needs (both present and future) of the individual.
IRAs gives individuals the chance to put funds away in a savings account until they enter retirement. However, there are several stipulations that one must consider as it pertains to allowable withdrawal, taxation, and being required to withdraw the funds at certain times.
The four common retirement accounts discussed below are Roth IRA, Traditional IRA, 401K, and SEP IRA. Though all four retirement accounts have the same underlining purpose, there are different requirements for each, as well as guidelines on who can obtain one.
Roth IRAs are viewed as being a delayed tax gratification because taxpayers are not able to enjoy the benefit until retirement.
The maximum contribution limit in 2019 and 2020 is $6,000 ($7,000 if over age 50) but is subjected to income limitation and tax filing status. For example, if a single person’s modified adjusted gross income (MAGI) exceeds $139,000, they can no longer contribute to their Roth IRA, while if married filing joint their MAGI cannot exceed $206,000.
A Roth IRA is referred to as after-tax contribution, but when withdrawn in retirement is tax free.
Early withdrawal from what has been earned on the contribution will result in a 10% tax penalty.
Retirement age for withdrawal purposes is 59 ½ years old and unlike a traditional IRA there are no required withdrawal amount.
Traditional IRAs allow taxpayers to enjoy direct and immediate tax benefit when filing their tax return
Like a Roth IRA, the maximum contribution limit in 2019 and 2020 is $6,000 ($7,000 if over the age of 50)
The upfront tax deduction that is allowed by a traditional IRA decreases the taxpayer(s) taxable income. For example, if a taxpayer’s total income was $60,000 and they contributed the maximum amount of $6,000, their taxable income would decrease to $54,000 ($60,000-$6,000).
For 2020, the income limit for a single person is $74,000, while for joint filers it is $123,000. If the taxpayer(s) income exceeds these limits they will not be able to enjoy the tax deduction benefits but may still contribute to the account.
If there is a withdrawal before age 59 ½, the taxpayer will be assessed a 10% early withdrawal penalty
At age 70 ½ taxpayers are required to take a minimum distribution referred to as RMD, if the taxpayer does not exercise this, they will be assessed a penalty.
401(K)s are workplace related retirement accounts, which are offered by employers; allowing employees to contribute to a retirement account along with contributions from the employer. 401(K)s share similar traits to that of a traditional or a Roth IRA, depending on the type chosen. In 2020 an employee can contribute up to $19,500 for the tax year. Early withdrawals are subjected to a 10% penalty, unless taxpayers can provide substantive reasoning/proof.
SEP (Simplified Employee Pension) IRA is typically for small business owners with a few to no employees. It is ideally a traditional IRA offered from the standpoint of being self-employed.
The maximum contribution for tax year 2020 is $57,000.
The amount contributed by the business is a tax deduction, while allowing the business owner to enjoy the benefits that it will provide in retirement.
The percentage contributed on behalf of the business owner must be reciprocated to the employee(s) as well. Hence why this plan is best for minimal individuals. For an employee to qualify for this plan they must be over age 21 and have worked for the company 3 out of the last 5 years.
Though there are several types of retirement accounts each individual account must be assessed based on the present and prospective future of the individual’s circumstances. Therefore, it is highly recommended that persons interested in establishing a retirement account seek professional advice of a financial advisor. Which will better help to understand the different impact and benefit each type of retirement account may offer now, later, or if at all, especially from a tax perspective.