Individual Retirement Accounts (IRAs)

An individual retirement account (IRA) investment vehicle is often one of the first things people think about when planning for retirement, and for good reason. While pensions have historically provided most Americans their retirement savings, IRAs are now a much more common retirement account.

IRAs offer valuable tax advantages—depending on the type of IRA selected—that make them an important step toward a comfortable and secure retirement for many investors. Because IRAs are a common account type, it’s important to be aware of how they work, the investment choices you have and the different types of retirement accounts that exist. Whether or not an IRA is a good option for you depends on the type you choose and your personal financial situation.

IRA Investment Choices

Individual retirement accounts can hold a wide variety of securities, including:

Cash
Money market accounts (MMAs)
Certificates of deposit (CDs)
Bonds, notes and other fixed income securities
Common stocks
Mutual funds
Exchange-traded funds (ETFs)

With so many investment options, what should you have? There is no one “right” answer for everyone because each asset class fills a specific need in your retirement plan. Typically, the best investments for you largely depend on your appropriate asset allocation—this is your mix of stocks, bonds, cash and other securities.

Generally speaking, if you have a long time horizon and need your assets to grow, your asset allocation should generally be weighted more heavily toward equity-focused investments.

If you have a shorter time horizon and low return expectations, then you may want to have more of your money in less-volatile asset classes such as fixed income instruments. For many investors, their asset allocation in retirement will be a mix of stocks and bonds, with other asset classes sprinkled in to help achieve the desired goals.

Among the many services we provide, we help our clients determine their optimal asset allocation.

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Contributing to an IRA

Traditional IRA

A traditional contributory, or pre-tax, IRA allows most people to contribute up to $7,000 per year.¹ If you are age age 50 or older, a “catch-up” provision allows you to contribute another $1,000 for a total of $8,000 per year.

Depending on whether you have a retirement plan through your employer, your income and tax-filing status, some or all of traditional IRA contributions could be fully tax deductible. A tax adviser can offer clarity on your particular situation and eligibility. Further, there are no income limits to contributing to a traditional IRA, even if you don’t qualify for a deduction. Additionally, assets in a pre-tax 401(k) plan may be rolled over into an IRA after leaving your employer.

SEP and SIMPLE IRAs

Both SEP (Simplified Employee Pension) and SIMPLE (Savings Incentive Match Plan for Employees) IRAs are designed for self-employed individuals, small-business owners and their employees. Both are similar to a traditional IRA in that they allow contributions to grow tax free until withdrawn and funds cannot be distributed until age 59½ without incurring a penalty. They differ over contribution limits and who makes the contributions.

With a SIMPLE IRA, the employee makes the majority of contributions, with a small contribution required by the employer. Employees can contribute up to $16,500 annually, with a $3,500 per year “catch-up” contribution if over age 50. Employers can match that amount up to 3% of the employee contribution. As with a traditional IRA, employees can take a tax deduction for their contributions to a SIMPLE IRA plan.

With a SEP IRA, the employer makes all of the contributions, which cannot exceed the lesser of 25% of the employee’s compensation or $70,000². Employees can take a tax deduction on contributions by their employer, up to a maximum of 25% of their annual compensation.

After leaving an employer, you can typically consolidate SEP or SIMPLE IRAs with any other traditional IRAs you may have.

Roth IRA

A Roth IRA has the same annual contribution limits as a traditional IRA; the main difference is when you pay taxes. With Roth IRAs, you don’t get a tax break up front on your contributions, but you also don’t have to pay tax on withdrawals during retirement—the exact opposite of a traditional IRA. A Roth IRA can also serve as the recipient account of a rollover from a Roth 401(k) account or other Roth Defined Contribution plan after leaving your employer.

Withdrawing From IRAs

Assets in your traditional IRA grow tax deferred until they are withdrawn—ideally at a lower tax rate than when you contributed. However, watch out for heavy penalties if you withdraw before a certain age. With traditional, SEP and SIMPLE IRA investments, you will pay taxes and likely incur a 10% penalty on any distributions taken before age 59½, unless you have a qualifying event.³ With a Roth IRA, you only pay a penalty on early distributions on earnings, not principal contributions.

A Roth IRA gives you a bit more flexibility than a pre-tax IRA. You can withdraw contributions at any time, for any reason, penalty-free as long as you’re over age 59½. You might face penalties if you withdraw any Roth IRA investment earnings before that age. Additional requirements for Roth IRAs may apply and you should consult a tax adviser if you have any questions.⁴

Additionally, pre-tax IRAs are subject to required minimum distributions (RMDs) starting when you turn 73. RMDs increase as a percentage of your IRA as you get older. Roth IRAs allow you to leave your money untouched as long as you like while you are alive. If you have inherited an IRA, you may want to consult a tax adviser to determine what withdrawals are required.⁵

Should You Invest in an IRA?

Your unique situation determines whether investing in an IRA is the best decision for you.

For example, if you have an employer-sponsored 401(k) or other retirement plan—especially one in which the company matches contributions—you might want to invest in that plan up to the contribution limit, which is generally higher than a traditional IRA.

In many cases, maximizing contributions to a 401(k) or other retirement plans that receive some sort of employer match can provide greater benefits, but 401(k)s and other employer retirement plans may have more restrictions on permissible investments compared to an IRA.

¹ https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits

² https://www.irs.gov/retirement-plans/plan-sponsor/simplified-employee-pension-plan-sep

³ https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions

⁴ https://www.irs.gov/publications/p590b

⁵ https://www.irs.gov/retirement-plans/required-minimum-distributions-for-ira-beneficiaries