Types of IRA Accounts

By W D Adkins

  • Overview

    An individual retirement account (IRA) is an investment account that offers either tax deferral or exemptions. Under Internal Revenue Service (IRS) rules, money normally must stay in an IRA until age 59 1/2. IRS rules allow you to use funds from an IRA for some other purposes, such as buying a first home or for qualified medical or educational expenses, but you must follow the guidelines or risk losing the tax advantages and incurring penalties. Each type of IRA has its own rules that you should become familiar with, in order to select the right type for your investment needs.
  • Types

    The two basic types of IRAs are the traditional IRA, which allows you to defer taxes on contributions and investment earnings, and the Roth IRA, which does not offer tax deferral but exempts earnings from taxes after retirement or 5 years, whichever comes first. Two alternative plans, SEP (simplified employee pension) and SIMPLE (Savings Incentive Match Plan for Employees) are alternatives to 401(k) programs used by persons who are self-employed and by small businesses. A self-directed IRA can be either a traditional or Roth IRA, but you bear more responsibility for managing the account.
  • Traditional IRA

    You can open a traditional IRA as long as you have earned income and are under age 70 1/2. Contributions are tax deductible and you may contribute up to $5000 per year (as of 2008). Earnings are not taxed as long as they remain within the account. After age 59 1/2, withdrawals are subject to regular taxes. Early withdrawal is subject to taxes and a 10 percent penalty unless it qualifies as an exception under IRS rules (for large medical expenses, purchase of a first home or certain educational expenses) or in the event you are disabled or have inherited the IRA.

  • Roth IRA

    You may contribute $5000 per year (as of 2008) to a Roth IRA, but cannot deduct the money from your taxes. Anyone with earned income can open a Roth IRA with no age restriction. After 5 years or age 59 1/2, whichever comes first, you may withdraw earnings without penalty and they are not subject to federal taxes. Contributions can be withdrawn at any time. The exceptions that allow early withdrawal are similar to the traditional IRA, except that withdrawals for buying or repairing a first home are limited to a total of $10,000.
  • SEP and SIMPLE

    The SEP IRA is designed for persons who are self employed and for small businesses to provide a retirement plan option with minimal administrative costs. SIMPLE IRAs do the same for small businesses (under 100 employees) that wish to match employee contributions. Both follow the same tax deferral and withdrawal rules as the traditional IRA. However, the contribution limits are higher. For SIMPLE the contribution can be up to 25 percent of income up to $10,500 per year ($14,000 after age 50 as of 2009). SEP contributions may be up to about 18.6 percent of net profit (the exact amount depends on a number of factors used to compute adjusted net income).
  • Self-Directed IRA

    Many IRAs are plans managed by a broker, bank or other party who acts as custodian. If you chose to manage your own investments, you still must have a custodian and most banks and brokerage firms will do this for a fee. However, you assume full responsibility for adhering to IRS rules, including choosing investments that are allowed in IRAs. Prohibited investments are treated as early withdrawals subject to both taxes and penalties by the IRS.

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