Individual Retirement Account (IRA) Tips You Should Know

Individual retirement accounts, or IRAs, are tax-deferred savings plans designed to be used for retirement. The terms and rules for IRAs vary from those in place for 401(k) retirement savings, and it's important to know the details about IRA programs. While they aren't secrets, there are a number of aspects to IRAs that seem to be little-known but should be on every retirement investor's radar.

Types of IRAs

IRAs come in three flavors, or at least two types and one which is a variation of another. The differences are found in the way taxes are treated, in regards to the contributions. With a traditional IRA, contributions are deducted annually on income tax filings. When the funds are withdrawn during retirement, they will be taxed, but likely at a lower rate than during a person's employed years.

A second type of IRA, a Roth IRA, uses different tax rules. In a Roth IRA, contributions are made after the money has been taxed, and the withdrawals are potentially tax-free. Certain conditions have to be met in order for the distributions to remain untaxed, such as age requirements, disability, death, or a qualified purchase of a first home.

Another type of IRA is a rollover IRA. The same terms apply as a traditional IRA, but an investor can roll over money from a 401(k) plan, potentially without any penalties.

SEP (self-employment pension) IRAs are designed for investors who are self-employed, and these individuals are allowed to make larger contributions to their plans annually. Business owners under the age of 50 can contribute up to 25 percent of their income or a maximum of $57,000 ($58,000 in 2021). Those 50 and over can contribute up to $64,500 to the plan for 2021.

A SIMPLE IRA, or Savings Incentive Match Plan for Employees, is made for small businesses who wish to contribute to employee retirement savings.

Who can save tax money with an IRA?

There is a catch, and like a dreaded Facebook relationship status, it's complicated. Not everyone qualifies for tax-deferred options. Eligibility is based on income levels, filing status, and how much is being invested into a 401(k) plan, if applicable. A qualified financial advisor can help an investor make these determinations.

You can have both

For many people who don't have a 401(k) option through an employer, opening an IRA is one avenue for saving money. However, not everyone is aware that those who already have a 401(k) plan can also start investing for retirement with an IRA as well if they meet the income and other eligibility requirements.

Diversify

One advantage to being enrolled in both a 401(k) plan and an IRA is to allow for greater investment choices. An IRA may have a broader range of investment options than an employee-based plan, and a diversified portfolio of investments is generally considered a healthier plan as it spreads the risks. When risks are spread out, the potential for big losses through market fluctuations can be reduced.

With IRAs, the investor is responsible to make decisions about the sectors in which they would like to invest. The mix of investment into stocks, equity funds, bonds, cash, or other financial vehicles is up to the investor. For this reason, it is especially important to review the fund's performance and adjust the strategy as the years go by. Whether or not having this power is an advantage or disadvantage depends on one's viewpoint, and possibly, luck.

Watch out for fees

In 2009, the Government Accountability Office reported that investors contributing to IRAs may be paying more fees than those saving for retirement through 401(k) plans. Because fees can really add up over many years, and the point of investing for retirement is to save, savvy investors will shop around for plans with the lowest total fees.

Going through withdrawal

Another perhaps lesser-known distinction between a traditional and a Roth IRA exists and should be considered when weighing options. Upon retirement, those with traditional IRAs have to make some distributions annually, which are subject to income taxes. Because taxes have already been paid on Roth IRAs, there is no requirement to make withdrawals from the savings during retirement.

Talk it over

Navigating the landscape of individual retirement accounts can be very confusing because of all of the details and tax implications involved, in addition to the problems inherent with speculating about the future of one's income and other economic conditions.

Having several discussions with several financial advisors, preferably with each one offering different financial products, would be a wise move before picking a retirement account.

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