You know you must save for retirement, but the path doesn’t always seem clear. While there are several options for retirement, one of the most popular is an IRA.
However, with multiple options ranging from a Roth to a self-directed IRA, there are many pros and cons when from choosing one account over the other. That’s why we’ve created this guide to help you understand the basics of IRA investing for retirement and tips to help you find the right custodian.
What is an IRA?
An individual retirement account (IRA) is an investment vehicle that lets you save money at a tax advantage. Depending on your type of IRA, the tax benefits can be realized up front or later in life when you begin to withdraw funds.
Once you open an IRA, you can contribute funds regularly to build wealth. Those funds can be invested in numerous assets, including stocks, bonds, mutual funds, and index funds. Investors also maintain the option to invest in a self-directed IRA, which extends investment options to include a wide range of non-traditional assets, like cryptocurrency, life stock, real estate, and even businesses.
Types of IRA
There are several types of IRAs that most individuals can invest in. Understanding the difference between each option can help you determine which type is best for you.
- Traditional IRA is an account that allows for tax-deferred contributions. Pre-tax dollars can grow in the account until retirement and are taxed upon withdrawal.
- Roth IRA delays the tax benefit until retirement. Under Roth IRA withdrawal rules, after-tax funds are contributed to the account, and funds can be withdrawn tax-free once you hit retirement age.
- SEP IRA is a retirement account that lets small business owners or self-employed individuals contribute to an employee’s traditional IRA account.
- SIMPLE IRA, short for Savings Incentive Match Plan for Employees, is another type of employee-focused IRa. Under this plan, both an employer and an employee can make contributions to the IRA account. Among employers looking for easier administration and lower costs, SIMPLE IRAs are often a more attractive option than 401(k).
- Self-directed IRAs (SDIRA): Self-directed IRAs significantly extend investment opportunities to include a wide range of assets. If you’re considering any of the IRA types listed above but want more flexibility, then the self-directed counterpart may be the best option. However, you’ll need to find a custodian specializing in SDIRA services.
Pros and Cons of an IRA
Like any investment option, there are benefits and drawbacks to an IRA. Here’s what you should consider:
- Simple to open and manage
- Accessible to most investors
- Account holders can choose how their funds are invested
- Not tied to an employer or organization
- Early withdrawals may be subject to income tax and penalties
- Account holders cannot borrow against their IRA
- Lower contribution limits when compared to other investment accounts
- SDIRAs require custodians for alternative investments
Which IRA Is Right for Me?
If you’re self-employed or running a small company and want to open an IRA for yourself or your employees, then SEP and SIMPLE IRAs are worth considering. But, for most investors, the decision is most often between a traditional IRA, Roth IRA, or SDIRA.
However, there are two major factors to consider when opening a tax-deferred retirement account.
As indicated above, the primary difference between a traditional and Roth IRA is when contributions are taxed. With a traditional IRA, contributions are typically pre-taxed funds and Roth IRA contributions are made with after-tax funds.
Though each investor is different, individuals who believe they’ll be in a lower tax bracket when they reach retirement age may want to consider a traditional IRA. Doing so allows them to take full advantage of deferred taxation.
Conversely, those who feel they will be in a higher tax bracket upon retirement may benefit from a Roth IRA, which is subject to upfront taxes but offers tax-free withdrawals during retirement.
Another factor to consider is your income. Traditional IRA contributions don’t carry an income limit. Roth contributions are income-dependent, with limits set by the IRS (more on that below).
Most IRAs restrict investments to straightforward asset classes like stocks and bonds. However, if you want to use your IRA to invest in alternative assets, like cryptocurrency, real estate, or private loans, then a self-directed IRA is right for you.
IRA Rules and Regulations
All IRAs are governed by a set of rules by the IRS. If you’re considering or already have an IRA, it’s important to be aware of these regulations, as they can change over time and, if you fail to adhere to them, can result in penalties.
Two of the most important rules, especially when comparing traditional and Roth IRAs, concern annual contributions and distributions and are as follows:
IRA account holders under the age of 50 can contribute $6,000 annually. The limit is extended to $7,000 for those $5,000 years of age or older. However, Roth IRA account holders are held to additional restrictions based on their modified adjusted income (AGI) and their marital status as indicated on their taxes.
An individual considered to be single, head of household, or married filing separately can contribute the maximum among (more on that later) each year as long as their modified AGI is less than $129,000. After that, the IRS limits the amount you can contribute, eventually 129,000 for single, head of household, and married filing separately (not living together for a year).
Joint filers and qualifying widows can make the full annual contribution as long as their modified AGI is less than $204,000. If their AGI is above that but less than $214,000, the contribution amount is reduced and reaches zero at $214,000
The IRS also sets contribution limits for other tax filers, including those who are married but filing separately but living with their spouse.
If you have a traditional, SEP, or SIMPLE IRA, you must take a required minimum distribution (RMD) at the age of 72. Before 2019 and the passage of the Setting Every Community Up for Retirement (SECURE) Act, distribution requirements started at 70 ½ years of age. Anyone who reached that age before the SECURE Act must abide by the previous rules.
Roth IRA holders don’t have to take RMDs. However, if the account holder dies, their beneficiaries generally do need to make withdrawals.
Finding an IRA Custodian
Also known as a trustee, a custodian administers an IRA account. Custodians can be banks, credit unions, or other trusted financial institutions. However, not all custodians manage self-directed IRAs.
Self-directed IRA custodians are qualified to work with alternative investment assets, like cryptocurrency, real estate, and promissory notes. And it’s important that you choose the best self-directed IRA custodian that has expertise in the assets you’re interested in.
Other important things to consider are the custodian’s reputation, reviews, and strong customer service.
Horizon Trust’s team of financial experts can help you choose the best self-directed IRA for your investment goals. Contact us today to get your retirement on track.