Understanding the Types of Individual Retirement Accounts

 

The Individual Retirement Account or IRA is a retirement savings account offered in the United States of America. The primary benefit of investments held in an IRA account is that the account holder need not pay taxes on money put in the account (in the case of a traditional IRA) or on money taken from the account (for a Roth IRA).

There are five different types of IRAs:

1. Traditional IRAThe original type of IRA called the “traditional” IRA provides tax benefits by deferring taxes on all funds invested in the account until the time that those funds are withdrawn from the account. All earnings within the IRA account are exempt from taxation until they are withdrawn as well. Upon withdrawal (withdrawal can occur any time after age 59 1/2) funds are taxed at the account owner’s current income tax rate.

2. Roth IRANamed for Senator William Roth who introduced the bill that created this type of IRA, the Roth IRA is the same in every respect to the traditional IRA with one important difference. Contributions are made with after tax dollars and qualified withdrawals can be taken tax free. This includes the original sums invested and all growth and earnings that have occurred over the life of the account.

3. SEP IRAA type of traditional IRA for self-employed persons that allows them to make contributions to an account established in their name instead of in the name of their company.

4. SIMPLE IRAA pension plan offered by an employer that allows both employee and employer contributions. This is similar to a 401k plan but the contribution limits are lower and administration of the plan is much simpler (and therefore less expensive).

5. Self-directed IRAA traditional, Roth, or SEP IRA in which the account holder makes all investment decisions instead of the trustee or custodian of the account making the investment decisions as is typically the case. A custodian still provides oversight of the account but all investment decisions are directed by the account owner.

No matter which type of IRA you choose, all offer a tax deferment or elimination benefit that makes them very popular investment vehicles.

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