With so many types of IRAs available, the details matter. Here’s how to choose an IRA for your long-term financial security.
IRAs are one of the most popular ways for Americans to save for retirement. According to the U.S. Census Bureau, over 18% of working-age Americans have an IRA, making it the second-most common retirement account behind 401(k)s.
But if you’re just starting out on your road to retirement, it can be difficult to parse the differences between the many types of IRAs, which can seem like an alphabet soup of obscure words.
Let’s start with the basics. By far, the most common question people saving for retirement have is “What does IRA stand for?” IRA, according to the IRS, means “individual retirement arrangement.” But the arrangements are typically accounts, so many people refer to them as an “individual retirement account.” Second, what are the benefits of an IRA? All IRAs are what’s known as “tax-advantaged,” which means that with an IRA, you pay less in taxes than you would if you simply socked away your after-tax earnings in a savings account until retirement.
The answer to “What IRA is right for me?” depends on your employment and financial situation. Let’s look at the different IRA types to help you figure out which one might be a good fit for you.
What is a Traditional IRA?
A traditional IRA works like this: You make an IRA contribution with pretax money. For IRA distributions, when it comes time to withdraw in your retirement, your withdrawals will be taxed at your income tax rate in the year you take the distribution.
There are no traditional IRA income limits, so you can contribute regardless of your income level. There is, though, a maximum IRA contribution, which for 2024 is the lessor of $7,000 (or $8,000 if you’re age 50 or older) or compensation from employment.
When it comes to distributions, you can withdraw from your traditional IRA without penalty once you turn 59½. If you take a distribution before that, you will incur a 10% early-withdrawal tax unless an exception applies, so it pays to plan carefully. Also keep in mind that there are IRA RMDs (required minimum distributions) beginning with the year you turn age 73. Your minimum IRA distribution depends on a number of factors including your life expectancy, so you should use an IRA withdrawal calculator or worksheet to determine how much you’re required to withdraw each year.
What is a Roth IRA?
Looking at a Roth IRA vs. a traditional IRA, there are a few key differences: You contribute after-tax dollars to your Roth IRA, but your withdrawals in retirement are typically tax-free. For this reason, Roth IRAs are generally considered to be useful for people who expect to be in a higher tax bracket when they retire.
There are no RMDs or mandatory withdrawals, but you will incur the 10% tax penalty for distributions made before age 59½. The same $7,000 yearly contribution limit for 2024 applies, and there is an additional income limit. Put simply, individuals who earn more than $161,000 ($240,000 for couples) in 2024 may not contribute to a Roth IRA. Like many other retirement accounts, the IRS has certain requirements for Roth IRA withdrawals, such as the so-called 5-Year Rule, wherein a distribution only qualifies as tax-free if it is withdrawn at least five years after you started contributing to the account. That requirement must be met for the entire distribution to be tax and penalty free, so make sure you check the rules and discuss with your tax professional to make sure you are complying.
What is a SEP IRA and a SIMPLE IRA?
A SEP IRA (Simplified Employee Pension IRA) is sometimes known as a self-employed IRA. Only employers (or self-employed individuals) can contribute to a SEP IRA. This IRA offers flexible annual contributions, which is useful if you’re self-employed and your cash flow varies year to year.
SEP IRAs work like traditional IRAs, so you contribute pretax dollars and you’re taxed upon withdrawals. The big difference is that you can make a much higher annual contribution, up to $69,000 for 2024 or 25% of your compensation, whichever is less.
A SIMPLE IRA (Savings Incentive Match PLan for Employees) is similar to a SEP IRA, but only businesses with fewer than 100 employees can use it. Much like a 401(k), it allows employers to match employee contributions. The SIMPLE IRA max contribution is $16,000 for 2024 or $19,500 for employees 50 and over.
Other IRAs
Regions Bank offers a variety of IRAs for your individual needs. Whether you’re looking for a traditional or Roth IRA, or more tailored options, such as fixed-rate IRAs and 18-month variable rate IRAs, visit a Regions branch today to learn more.
Three things to do
- Use our IRA comparison tool to compare different types of IRAs and find the right one for your needs.
- Read more about retirement planning and consider how an IRA might help you pay for your expenses upon retirement.
- Take a Next Step course on preparing for retirement.
