Traditional Individual Retirement Accounts ( Traditional IRAs) let you deposit pre-tax income to a retirement account where that money grows tax deferred until you take it out during retirement. While you can decide to take it out earlier, you receive a 10 percent penalty on the amount withdrawn for doing this. Once you reach retirement after the age of 59 and a half, you can take your money out without a penalty. The money you withdraw is then taxed at your current income tax rate. The Federal Deposit Insurance Corporation (FDIC) offers insurance for up to 250,000 dollars which are in traditional IRA accounts.
The contributions to your traditional IRA are tax deductible. If you are under 50, you can deposit up to 6000 dollars each year. If you are over 50, you can deposit up to 7000 dollars each year. This lets you “catch up” if you did not save as much in your younger years. Contributions have to be made by the tax deadline each year (April 15).
There is not a specific age limit after which you cannot contribute any more to your traditional IRA, but you are obligated to take required minimum distributions from your account at 72.
Exceptions where you do not incur the penalty for withdrawing early include:
Roth Individual Retirement Accounts (Roth IRAs) let you deposit after-tax income to a retirement account where that money grows tax deferred until retirement and where the withdrawals are tax-free. Unlike traditional IRAs, Roth IRA contributions are not tax deductible and you can make contributions for as long as you are earning an income.
When it comes to the contribution limits are the same as for the traditional IRA, but who can make contributions to your account is much more flexible. You can make regular contributions like you can with a traditional IRA, but you can also be funded by spousal IRA contributions, transfers, rollover contributions, and conversions. Contributions have to be made by the tax deadline each year (April 15).
A key characteristic of the Roth IRA is that you cannot contribute to it if you earn too much. In 2020, earning too much meant earning more than $139,000 if you are single and $206,000 if you are a married couple.
To open a Roth IRA, you need to find an institution (banks, brokerage companies, federally insured credit unions, and savings and loan associations) that has IRS approval to offer IRAs. When you establish an IRA, you get 2 documents: IRA disclosure statement and IRA adoption agreement and plan document. Different institutions offer different investment options with different amounts of risk. The Federal Deposit Insurance Corporation (FDIC) offers insurance for up to 250,000 dollars which are in Roth IRA accounts.
The same exceptions for penalties for withdrawals apply as for Traditional IRAs.
401(k)s are tax-advantaged, defined-contribution retirement accounts offered by employers. Employees can make contributions to their 401(k)s through automatic paycheck withholding and employers can choose to match those contributions. Like the two previous retirement accounts, there is a traditional 401(k) and a Roth 401(k) whose main difference is how they treat taxation.
If you leave a company you have different options: (1) take the money out, (2) transfer it into a different IRA, (3) leave it with your old employer and (4) move it to a new employer. The first one is the worst option because you incur the penalties from withdrawing the money. All other three options have similar benefits and what option is a better fit depends on how often you change your job and how good the plan at your previous employer is.
A simplified employee pension Individual Retirement Account (SEP IRA) is a retirement savings option for which employers can make tax-deductible contributions on behalf of their employees. As of 2020, the contributions cannot exceed 25% of the employee’s compensation for the year or 57,000, whichever is smaller.
A Savings Incentive Match Plan for Employees Individual Retirement Account (SIMPLE IRA) is a retirement savings plan in which small businesses of up to 100 employees can match 2% and up to an optional 3% of the contributions that their employees make towards their retirement. If you are under 50, you can deposit up to 13,500 dollars each year. If you are over 50, you can deposit up to 16,500 dollars each year.