Investing

What Is an IRA?

Elyse Steinhaus

You don’t need access to a company 401(k) to open a tax-advantaged retirement account. Just about anyone with an income—or even a spouse with an income—can open an Individual Retirement Account (IRA) and invest money for the future.

Three popular types include a traditional IRA, Roth IRA and SEP IRA.

Traditional IRA

For 2019, you can invest up to $6,000 (or $7,000 if you’re 50 or older), using money you’ve already paid taxes on. You will pay taxes on withdrawals you make in retirement, but you may be able to deduct your contributions—depending on your household income and access to workplace retirement plans—and cut your tax bill now.

Once you reach the year you turn 70½ (don’t ask—IRS rules), you can no longer contribute, and you must start taking minimum withdrawals. Because this money is meant for retirement, tapping it before age 59½ means you’ll owe regular income taxes, plus a 10-percent penalty in most cases.

Roth IRA

Named after the senator who championed the plan, a Roth IRA isn’t tax deductible today, but your money grows and can be withdrawn tax-free down the road. You can contribute up to $6,000 for 2019 ($7,000 if you’re 50 or older)—but there are income restrictions. To max out the account in 2019, you must earn less than $120,000, or $189,000 if you're married and filing jointly. There are no age restrictions on making contributions.

A major perk of Roth IRAs is that you can withdraw your contributions anytime without penalty. However, if you dip into your investment earnings before 59½, you may owe a 10-percent penalty and taxes. The exception is if you have had your Roth IRA for at least five years and you’re making the withdrawal because you are disabled or if you are using it to rebuild or buy a first home.

SEP IRA

Simple Employee Pension (SEP) IRAs are meant to incentivize people who are self-employed or small business owners to save (a lot) for retirement. In 2019, you can contribute $56,000 or 25 percent of your compensation, whichever is less. You can deduct most or all of your contributions, and you won’t pay taxes until you withdraw the money in retirement. You must start taking minimum withdrawals at age 70½.

Before signing up for a SEP IRA, know this: If you have employees the IRS deems eligible to participate in your plan—who are 21 or older, have worked for you at least three of the last five years and received at least $600 in compensation this year—you must also contribute on their behalf. And remember: If you tap your money before you’re 59½, you’ll pay regular income taxes and the 10-percent penalty.

It’s worth noting that there are certain situations, like buying a first home or covering qualified education expenses, in which you can avoid the early withdrawal penalty for all three IRA types. But you’ll still have to pay taxes on a traditional or SEP IRA (and sometimes Roth, too, if you’re withdrawing earnings early), and you’ll be sacrificing potential investment gains during the time your money’s out of the market.

This story was updated in January 2019.

This information is being provided for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. You should consult your tax or legal adviser regarding such matters.

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