Choosing the Right IRA Account

Choosing the right IRA account requires some planning. There are several types of IRA accounts such as traditional, Roth and simplified employee pension (SEP) accounts. Whether you have an existing IRA or are eager to set up a new one, selecting the type of IRA account you will want to have depends upon your income, your existing retirement accounts, marital status, age and your expected tax bracket.

What Is an IRA?

In simple terms, an IRA is a tax-advantaged retirement savings account for people who have earned income, that enables them to put aside a certain amount of money per year and reap tax advantages. IRAs can be additional savings that you add to your existing retirement plan through your employer. If you have an existing 401(k) plan, you can also roll it over to an IRA. (For more, see: Will Your Retirement Income Be Enough?)

Annual Contribution Limit

You are eligible to have more than one IRA but the annual contribution limit across ALL account is $5,500 if you’re under age 50, and $6,500 if you’re 50 or older.

There are two types of IRAs:

1) Traditional IRA
2) Roth IRA

Both IRA plans have their own unique guidelines and benefits.

Traditional IRA

In this type of IRA, your contributions do not require a tax payment upfront. Growth is tax deferred. You only pay taxes when you withdraw from your IRA account during retirement.

Roth IRA

In this type of IRA, your contributions incur taxes at the onset. However, you can withdraw from your account with paying taxes. Your account’s growth also does not incur taxes.

Choosing the Right IRA

Choosing the right IRA does involve some planning as you can qualify for multiple account types depending upon your age, income and contributions to other retirement accounts. In deciding between account types, knowing the difference between your current and future tax bracket also have an impact on your selection. Depending upon your individual situation, it may be helpful to implement advanced IRA planning to extract additional tax benefits through conversion between different types of IRAs.

Often the qualifying rules for IRAs are misunderstood. It is important to have some information handy to make the best decision for you. This includes:

  1. Income filing status.
  2. Tax year to assign your contribution.
  3. Your age by the end of the tax year.
  4. How much you will save in IRA accounts this year.
  5. Your pre-tax annual income.
  6. If your employer offers a retirement plan such as a 401(k), 403(b) plan.
  7. Your expected tax rate at retirement.

For example, a single 35-year-old person whose pre-tax income is $50,000 and does not have a retirement plan via their employer and can save up to $5,500 for the 2015 year, could invest in both a Roth IRA and a traditional IRA deductible at $2,750 each.

This investment approach of an equal amount in a Roth IRA and traditional IRA is suitable because the future tax rate is likely similar to the current rate. Having both pre-tax and post-tax accounts also can help in controlling income and taxes in retirement. (For more from this author, see: 3 Steps to Prepare Financially for Retirement.)