Understanding The Different Types of IRAS And What They Mean To You

As far as most of you are concerned there's simply one type of IRA (Individual Retirement Account), and that the rest is just jargon used by financial advisors to confuse you. The fact remains however that there are 11 different types of IRA, each with their own specific nuances and regulations.

You've probably heard people talking about Roth and SEP IRAs but you never wanted to ask what the difference was in case you looked foolish, but this article aims to end your confusion surrounding the most popular types of IRAs.

IRA: The Basics

An IRA is an Individual Retirement Account, which is a form of investment you pay into over several decades. The money you pay into your IRA is then invested in other financial products such as bonds and the stock market. Once you reach retirement age you can then "cash in" your IRA, although you can make early withdrawals from certain types of IRAs as long as you're willing to pay a financial penalty for doing so.

Traditional IRA

This type of retirement account is available to those under 70.5 years of age and the funds invested in it can be used to purchase a wide variety of other financial investment products. With a traditional IRA you must begin withdrawing from it by the age of 70.5 at the latest, and if not then you can suffer penalties for failing to withdraw funds from the IRA as previously agreed. A traditional IRA is available to anyone and your deductions to it may also be tax deductible depending on certain factors.

Roth IRA

The first thing you need to know about a Roth IRA is that your contributions to it are not tax deductible, and a qualified distribution is one that is taken at least five years after the taxpayer establishes his or her first Roth IRA and turns age 59.5. The major benefit of a Roth IRA is that as long as you stick to the rules, your earnings from it, including your original investment, are 100% tax free.

SEP-IRA

SEP-IRA contributions are treated as part of a profit-sharing plan. For employees, the employer may contribute up to 25% of the employee's wages to the employee's SEP-IRA account.  For example, if an employee earns $80,000 in wages, the employer could contribute up to $20,000 to the SEP-IRA account. Employers are allowed to claim tax deductions for contributions made to this type of IRA.

SIMPLE IRA

SIMPLE stands for Savings Incentive Match Plan, and this type of retirement account is basically a traditional IRA which is set up by a small business, or self-employed individuals, for its own employees i.e. themselves in many cases. With this type of IRA an employee can contribute up to US$12,000 per year (in 2013), although this does vary depending on inflation. A SIMPLE IRA allows small businesses to offer some of the same perks an employee might get from larger companies with more elaborate IRA offers.

When is a good time to start planning your IRA?

Well considering that some of them allow you to start making withdrawals when you're just 59.5 years of age the best time to start making contributions to an IRA is right now!

Obviously you should seek professional financial advice from a CPA or financial consultant on which type of IRA will best suit your own personal financial circumstances.