Your Quick Reference Guide to IRAs
Individual retirement accounts (IRAs) are one of the most popular ways to save for retirement, yet many people lack a full understanding of these accounts. From the different types of IRAs to contribution limits to required minimum distributions, following are answers to common questions regarding IRAs.
#1 – What are the different types of IRAs, and how do I know which one is right for me?
Because traditional and Roth IRAs are the most common and widely used, most of our discussion will focus on those two IRA types. However, it’s helpful to be aware that there are six main types of IRAs.
Traditional IRAs are the most common and well known. Contributions to these accounts are deducted on the tax return, and investment earnings grow tax-deferred within the account. Due to their pre-tax nature, traditional IRA assets are taxed as ordinary income when they’re withdrawn from the account.
This type of IRA typically works best for individuals who are in a higher tax bracket now than they anticipate being in during retirement. Traditional IRAs are also a smart choice for individuals who aren’t eligible to participate in an employer-sponsored retirement plan.
In contrast to traditional IRAs, contributions to Roth IRAs are made with after-tax funds. Although there are no immediate tax advantages to contributing to a Roth IRA, assets within the account grow tax-deferred, and withdrawals during retirement are tax-exempt.
A Roth IRA typically makes sense for those who anticipate being in a higher tax bracket in retirement than they are now.
A simplified employee pension (SEP) IRA is a type of traditional IRA established and funded by an employer; employees are not allowed to make contributions to these accounts. Within a SEP IRA, earnings grow tax-deferred and withdrawals in retirement are taxed as ordinary income.
SEP IRAs can be a good option for small-business owners who wish to offer retirement benefits to their employees but don’t want to take on the startup and operating costs of a typical employer-sponsored retirement plan.
A savings incentive match plan for employees (SIMPLE IRA) is a type of retirement savings vehicle that can be used by both business owners and their employees. In contrast to a SEP IRA, employees are eligible to make tax-deductible contributions to the plan. Plan participants can also roll over money from a SIMPLE IRA to a traditional IRA after two years of participation in the SIMPLE IRA.
SIMPLE IRAs have lower contribution limits than SEP IRAs and 401ks and are intended for small businesses with fewer than 100 employees.
In order to contribute to an IRA, the IRS requires that an individual have earned income. However, if you’re married and one spouse isn’t working, both spouses can contribute to separate traditional or Roth IRAs. To be eligible, couples must have taxable income and file a joint tax return.
Spousal IRAs are intended to help low-income or non-working spouses save for retirement.
A rollover IRA is an account used to hold assets from a previous employer-sponsored plan, such as a 401k. These accounts allow you to maintain the tax-deferred status of retirement plan assets while transferring those assets into an account under your name.
Rollover IRAs are intended for individuals who maintain a balance in an employer-sponsored retirement plan and wish to preserve the tax-deferred status of those assets while moving them away from the employer.
#2 – Are all IRAs subject to required minimum distributions (RMDs)?
No, RMDs apply only to pre-tax retirement accounts, such as traditional IRAs. The IRS requires that you begin withdrawing a portion of your pre-tax retirement assets each year, beginning in the year you reach age 73. Because Roth IRA contributions are made with after-tax funds, they’re not subject to the same RMD rules.
Think about it this way: regardless of how you save for retirement, Uncle Sam will eventually want his cut. You can either pay taxes upfront and not be subject to RMDs during retirement (Roth IRA), or you can realize the benefit of lower taxable income during your working years and be subject to RMDs (and the associated income tax) during retirement (traditional IRA). Your wealth manager can help you decide which scenario makes the most sense for you.
#3 – What are my IRA investment options?
IRAs offer a lot of investment flexibility. Within most IRAs, you can invest in a virtually unlimited universe of stocks, bonds, exchange-traded funds and mutual funds. Your specific allocation should be in line with your overall portfolio, risk tolerance and goals for the future, which is why it’s wise to work with your wealth manger to select a custom investment mix.
#4 – Are there limits to how much I can contribute?
Yes. Individuals can contribute a combined total of $7,000 to traditional and Roth IRAs in 2024. Those age 50 and older can make an additional $1,000 catch-up contribution, for a total combined contribution of $8,000.
Those with higher incomes are gradually phased out from contributing to both traditional and Roth IRAs. In 2024, single taxpayers with an annual adjusted gross income between $146,000 and $161,000 are gradually phased out of contributing to a Roth IRA, and those with income greater than $161,000 aren’t eligible to contribute. For married couples filing jointly, Roth IRA contributions are phased out between $230,000 and $240,000 of income, and no contributions are permitted for couples who earn more than $240,000.
For traditional IRAs, if you or your spouse has a 401k and your income exceeds the below thresholds, you may be ineligible to deduct your traditional IRA contribution.
As a single filer with a workplace retirement plan, you can deduct your full IRA contribution if your 2024 income is less than $77,000. If your income is between $77,000 and $87,000, you’re likely eligible for a partial deduction, but no deduction is permitted for those who make more than $87,000 and participate in an employer-sponsored retirement plan.
For married couples filing jointly, deductions are phased out between $123,000 and $143,000 of income, and no deduction is permitted for couples who earn more than $143,000 and contribute to a workplace plan.
If you’re not covered by a workplace retirement plan, the income limit isn’t applicable and you’re eligible to contribute up to the full $7,000 limit.
#5 – Can I save in an IRA if I already have a 401k through work?
Absolutely! Contributing to both a 401k and an IRA can be a great way to save for retirement. Just keep in mind the limits from #4 mentioned above.
#6 – Can I withdraw funds from my IRA before I retire?
Yes, you can withdraw money from an IRA before you retire, but there may be disadvantages for doing so. While withdrawals from IRAs can be made at any time, there are three main disadvantages to withdrawing funds prior to retirement.
Early withdrawal penalty
If you withdraw funds from an IRA before age 59 ½, you may be subject to a 10% federal early withdrawal penalty, as well as potential state-imposed penalties.
Although there are no penalties for withdrawing Roth IRA contributions (the money you put into the Roth IRA) prior to retirement, you typically need to pay taxes and incur the 10% penalty on any earnings withdrawn before the age of 59 ½ unless they qualify for one of the below exemptions:
- Withdrawing funds for a first-time home purchase (up to $10,000)
- Qualified education expenses
- Unreimbursed medical expenses (must be more than 7.5% of your adjusted gross income)
- Qualified education expenses and health insurance premiums if you’re out of work for an extended period of time
Because contributions to traditional IRAs are made with pre-tax dollars, any withdrawals are added to your taxable income during the year in which they’re taken. This could put you into a higher tax bracket for the year (as mentioned above, if you withdraw funds from an IRA before age 59 ½, you may be subject to a 10% federal early withdrawal penalty, as well as potential state-imposed penalties).
Long-term savings consequences
Any money withdrawn from your IRA is no longer there to support you in retirement. Given the potential impact of compounding returns, early withdrawals can have serious consequences on your long-term retirement savings.
Could you use some help with your retirement savings strategy? Creative Planning is here for you. Our experienced teams take time to get to know you, your current financial situation, your goals for the future and any challenges you may face before offering well-informed, custom solutions to meet your needs. For more information, please schedule a call with a member of our team.