What is an Individual Retirement Account?

An individual retirement account refers to an investing tool used by individuals to earmark or set aside funds for retirement savings. Various IRA types exist, as of 2018 and they include Roth IRAs, traditional IRAs, SEP IRAs, and SIMPLE IRAs. Sometimes called individual retirement arrangements, IRAs can be made up of a number of financial products like bonds, mutual funds, or stocks. A self-directed IRA refers to a traditional or Roth IRA type which allows investors to make every investment decision for their account and also allows access to a wider range of investments, like private placements, real estate, and tax liens.

How Does an Individual Retirement Account Work?

Individual taxpayers establish both traditional and Roth IRAs, as against self-employed individuals and small business owners who establish both SEP and SIMPLE IRAs. Generally, these accounts set up via a brokerage. When searching, you can find some of the most suitable places to open an account with Investopedia's list of best brokers for IRAs.

Traditional IRAs

Most times, contributions to traditional IRAs can have tax deducted from them. For instance, if an individual contributes $5,500 to their IRA, that amount can be claimed by them as a deduction on the return of income tax and the Internal Revenue Service won't apply income tax to such earnings. However, when the person withdraws funds from the account while in retirement, the withdrawals are taxed at the normal income tax rate. As of 2018, yearly individual contributions to traditional IRAs can't surpass $5,500 most times. If you are 50 years or older, you can use catch-up contributions to contribute up to $6,500 each year. Whether your employer offers a retirement plan can determine how deductible your traditional IRA contributions are. As of 2018, if you file as household head or as a single person with an available retirement plan via work, as well as, a $63,000 or less modified adjusted gross income (MAGI), your IRA contributions can be deducted fully. If your earning is more than $63,000 but below $73,000, then just a portion of your contributions might be deducted. If you have an adjusted gross income higher than $73,000, then your IRA contributions aren't deductible, except if you don't have an available retirement plan through your employer. The IRS has added rules for those using a different filing status, such as married filing separately or married filing jointly. Starting at age 70, traditional IRA savers are mandated to start taking minimum distributions (RMDs). These minimum distributions would be based on the size of their account and life expectancy. Failure to comply may bring about a tax penalty equalling 50% of the required distribution amount.

Roth IRAs

While Roth IRA contributions aren't tax-deductible, qualified distributions are free of tax. This implies that you utilize after-tax dollars in contributing to a Roth IRA, but as this continues growing, you don't face any tax on investment gains. Upon retirement, you are free to withdraw from the account without any income tax attached to your withdrawals. Roth IRA doesn't have RMDs in that if you're not in need of the money, there's no need withdrawing it from your account and worrying about penalties for not doing so. However, a limit exists as to those that can make contributions to an IRA. As of 2018, married tax filers or those filing jointly, for instance, can contribute up to the yearly contribution limit if they have a combined MAGI that is lower than $189,000. In a situation where their MAGI is higher than $189,000 but lower than $199,000, it will be possible for them to make a reduced contribution. Roth IRA contributions relinquish totally when combined MAGI surpasses $199,000. The IRS sets more income limits for single filers, married couples filing separately, and household heads.

Simplified Employee Pension IRAs

Individuals who are self-employed, like freelancers, small business owners, and independent contractors can establish SEP IRAs. The taxation rules for withdrawal which a traditional IRA adheres to is also adhered to by a SEP IRA. For 2018, simplified employee pension IRA contributions are restricted to a 25% compensation or $55,000, depending on that which is less. Business owners who establish a simplified employee pension IRA for the employees of the company can subtract the contributions from their reported business income and then secure a lesser tax rate on the income. Nevertheless, company employees are not permitted to make contributions to their accounts and their withdrawals are taxed by the IRS as income.

SIMPLE IRAs

The SIMPLE IRA which is also known as the Savings Incentive Match Plan for Employees is also intended for both self-employed individuals and small businesses. It follows the same withdrawal taxation rules as a traditional IRA. But unlike SEP IRAs, SIMPLE IRAs give employees permission to contribute to their accounts, and the employer is also required to make these contributions. Every contribution here is tax-deductible, potentially pushing the employee or business into a lesser tax bracket, which is capable of reducing one's tax bill. For 2018, the SIMPLE IRA limit for employee contribution is $12,500, having a $3,000 catch-up contribution permitted for savers aged 50 or older.

Types of IRA

Limit of Contribution (2018) - $6,000(50 years old and under); $7000 (Older than 50) Tax-free Distributions Non-Tax-deductible Contributions Subject to RMDs Starting at Age 70?

Traditional IRA

$5,500; 6,500 if aged 50 or older Individual deduction amounts are based on filing status, income, and also retirement plan coverage via your employer Couples and individual taxpayers can establish. Roth $5,500; $6,500, if aged 50 or older Couples and individual taxpayers; subject to limitations of MAGI

Simplified Employee Pension

The lesser of $55,000 or 25% of compensation Business deductions made for employee contributions are restricted to the lesser of either your total contributions or a 25% rate of employees' compensation. Individuals who are self-employed must utilize a special formula for calculating the contribution amount they can deduct Self-employed individuals and small business owners

SIMPLE

$12,500; $15,500 if aged 50 years or older Every contribution made by the plan owner to employees' SIMPLE IRAs are tax-deductible For those who are self-employed, they can deduct contributions which were made to the

SIMPLE IRA

Self-employed individuals or small business owners An individual account can be owned by each spouse. IRAs can't be jointly held. A spousal IRA can be set up by couples for a spouse who isn't working.