What is IRA?

IRA stands for Individual retirement Account. Mainly there are 7 types of IRA and these are.

• Traditional IRA.
• Roth IRA
• SEP IRA
• Non-Deductible IRA
• Spousal IRA
• Simple IRA
• Self-Directed IRA

Traditional IRA

The traditional IRA remains the most popular of the individual tax-advantaged retirement savings accounts. Key features include:

• An upfront tax break of up to $6,000 in 2020 and 2021, plus an extra $1,000 catch-up contribution if you're age 50 or older: Contributions may be deductible, thus lowering your taxable income for the year. It all depends on your current income plus whether you or your spouse has a workplace retirement plan.
• Investment earnings are not taxed as long as the money remains in the protection of the account.
• Withdrawals in retirement are taxed at your tax rate at that time.

Best for: Those who are in a higher tax bracket now than they think they’ll be in during retirement, as well as workers who do not have access to (or are not eligible to contribute to) a workplace-sponsored retirement plan. 

Roth IRA

The Roth IRA provides a nice tax-saving counterbalance to the traditional IRA. Key features:

• While contributions are not deductible — meaning there’s no upfront tax break — withdrawals in retirement are completely tax-free.
• The maximum annual contribution is $6,000 ($7,000 if age 50+). Eligibility to contribute to a Roth is based on your income, but if you earn too much to contribute, there’s a completely legal way to open one anyway via a backdoor Roth.
• Roth IRA withdrawal rules are more lenient, allowing tax- and penalty-free withdrawals of contributions at any time. Taxes and penalties apply to withdrawing earnings before retirement, with a few exceptions.

Best for: Savers who anticipate being in a higher tax bracket in retirement, to take advantage of those tax-free withdrawals. A Roth is also a better choice than a traditional IRA if you might need to access some of the money before retirement age, although we discourage dipping into retirement savings early. Interest piqued? Here’s a rundown of the best Roth IRA accounts.

SEP IRA

Simplified employee pension IRA. Even though it’s a type of traditional IRA, it is set up and funded for employees by an employer, who gets tax benefits for the effort. Within a SEP IRA, earnings grow tax-free and distributions in retirement are taxed. Other highlights:

• Annual contribution limits are much higher than what’s allowed in other tax-favored retirement accounts — the lesser of up to 25% of employee compensation or $57,000 in 2020 and $58,000 in 2021. (See this IRS.gov page for more information.)
• An employer must contribute equally (on a percentage basis of salary) to all employee accounts, including their own.
• Contribution size may vary year to year based on the business’s cash flow but must always be equal for all eligible workers.
• Employees are not allowed to contribute to the plan via salary deferral; must have worked for the employer in at least three of the last five years; and must have earned at least $600 in compensation during the year to be eligible.
• Sole proprietors (aka Employee No. 1 and only) can open a SEP IRA for themselves.
• Catch-up contributions for workers 50 and older are not allowed.

Best for: Small-business owners who want to avoid the startup and operating costs of a conventional retirement plan, as well as the ability to supersize their retirement stash and get a tax deduction on any contributions made for employees. Just be aware that if you’re both the employer and employee, it’s important to follow SEP IRA rules to avoid running afoul of the IRS.

Non-Deductible IRA

A traditional IRA may be tax deductible or may not be a tax deductible? If you (or your spouse) has a retirement plan at work and your income exceeds the IRA income limits, then you may not be able to deduct your traditional IRA contributions. But you can still put money into the IRA. The main things to know about a nondeductible IRA:

• Contributions are made with after-tax dollars and, as the name makes clear, are not deductible. But ...
• You still get the perk of tax-deferred growth on earnings within the account.
• Taxes in retirement are due on any earnings growth you withdraw, but not the principal, since the account was funded with already taxed dollars.

Best for: Those who don't qualify to contribute to a Roth IRA or a deductible IRA and later convert this to Roth via back door Roth IRA 

Spousal IRA

IRS rules state that a person must have earned income to be eligible to contribute to an IRA. But there’s a workaround for married taxpayers: If one half of the twosome isn’t working — or brings in a very low income — you still can both contribute to your own separate IRAs (either Roth or traditional).

• Couples must file a joint tax return and have taxable compensation to be eligible.
• Contribution limits are the same as for a traditional or Roth IRA: the nonworking spouse can contribute up to $6,000, or $7,000 for those 50 or older, in 2020 and 2021. The working spouse can contribute the same amount to his or her own IRA.
• The total amount contributed to both IRAs must be the lesser of your joint taxable income or double the annual IRA contribution limit (e.g., $12,000 for those under 50).
• The account can be funded with money from either spouse’s earnings but must be opened in the nonworking spouse’s name using his or her Social Security number.

Best for: Low-income or non working individuals married to someone who has earned income.

Simple IRA

The SIMPLE IRA (Savings Incentive Match Plan for Employees) is similar in many ways to an employer-sponsored 401(k). It primarily exists for small companies and the self-employed. Unlike the SEP IRA, employees are allowed to contribute to the account via salary deferral. Some plans even allow an employee to select the financial institution they want to use to hold their account. Tax-wise, SIMPLE IRA rules are much like those that apply to traditional IRAs. Other considerations:

• Contribution limits are lower than for 401(k)s — $13,500 versus $19,500 in 2020 and 2021.
• Employers are generally required to kick in up to a 3% matching contribution or a fixed contribution of 2% of each eligible employee’s compensation.
• To qualify to participate in a SIMPLE IRA, an employee must have earned at least $5,000 during any two years before the current calendar year and expect to receive at least that amount in the current year.
• Unlike the SEP, catch-up contributions are allowed: If you’re 50 or older, you can save an additional $3,000.
• Unlike most workplace plans, participants can roll the money from the account into a traditional IRA after two years of participation in the SIMPLE IRA plan.
• Early withdrawals from a SIMPLE IRA within the first two years of contributing to the account may be subject to a punishing 25% penalty (on top of regular income taxes).

Best for: Smaller companies with fewer than 100 employees. If you’re self-employed, you may be better off opening a SEP IRA for the higher contribution limits.

Self -Directed IRA

Self-directed IRAs (in the traditional and Roth flavors) are governed by the same eligibility and contribution rules as traditional and Roth IRAs except for one big difference: What goes in the account.

The other IRAs covered in this article typically limit investments in the account to common vehicles like stocks, bonds and mutual funds. In a self-directed IRA, you’re allowed to own assets such as real estate, hard assets like gold and privately held companies. Some must-knows:

• Setting one up requires a trustee or custodian who specializes in the less typical types of investments you’re interested in holding in the account.
• The IRS does not allow holding things like collectibles and life insurance in the account.
• There are many prohibited “self-dealing” transactions within a self-directed IRA (e.g., mowing the lawn or fixing the faucet in a rental property owned in the IRA) that the IRS deems equivalent to taking a distribution. These can trigger taxes and penalties on the entire account.

Best for: Experienced investors who want access to alternative investments such as real estate and nontraditional businesses. While there are benefits to using this type of account to save for retirement (mostly the potential for higher returns), do not pass go until understanding the risks of self-directed IRAs.

Traditional IRA vs. Roth IRA

Mainly for a salaried employee, there are two types of IRA (1) Traditional IRA and (2) Roth IRA. What are differences? Traditional IRA vs. Roth IRA, based on fact an example.