What is an IRA?
An IRA or individual retirement account is a savings account with specific tax advantages regarding people saving for the long-term future. While an IRA is not an investment, it is within an IRA account where investments such as mutual funds, bonds, and stocks are held. An IRA can be open to small business owners in addition to those who are self-employed.
Types of IRS accounts include SIMPLE, SEP, Roth, and Traditional. The differences are within their rules and conditions, most often concerning their tax benefits. A Participant-directed account is where an IRA is provided by an institution and allows for different types of investments. A participant-directed account allows various alternative investments such as real estate, private mortgages and private company stocks. However, there is a possibility of fraud when engaging in these types of accounts.
Traditional IRA
The amount you can deposit into your account, known as a contribution, is limited by various factors such as age, income, filing status, and employer contributions. In 2020, the contribution limit ranged from $6,000 to $7,000. With a traditional IRA, your contributions are pre-tax, meaning you pay income tax when your withdrawal the funds after they have most likely grown.
Roth IRA
A Roth IRA has different rules that allow it to have a slew of other benefits compared to a Traditional IRA account. Specifically, you have in deposit investments post-tax. Post-tax means the money you have deposited into a Roth IRA account is earned income you have already paid income on. The limit for contributions in 2020 is $6,000 or $7,000, depending on your age. The most significant benefit about a Roth IRA is that the distributions or withdrawals from the account are tax-free. Because you pay into this account post-tax, all the money you make on this account can be withdrawn tax-free. Notably, there are a few restrictions on what and when you disburse funds from this account. You must own the account for five years and are over 59.5 years old. However, if you are younger than 59.5, you can disburse funds tax-free if you use the money to pay for college expenses or purchase your first home. If you decide to withdrawal early, you incur a significant penalty of 10 percent on gains as well as having your income taxed. It is in your best interests to adhere to their guidelines.
SEP-IRA
Simplified Employee Pension Plan, or SEP for short, is a type of IRA which employers (including self-employers) can establish. The feature of this account is that employers are allowed to make tax deductions for contributions made to SEP IRA and make contributions to each eligible employee’s plan as the employer sees fit. Additionally, small employers get federal tax credits to offset the costs of starting these accounts and SIMPLE IRA accounts. Unlike employee stock options, with a SEP IRA, contributions are immediately vested. The contribution limit for 2020 is $57,000 or 25 percent of the employee’s compensation, whichever is lower. SEP IRAs have significantly higher contribution limits than Roth or Traditional IRAs.
SIMPLE IRA
A Savings Incentive Match Plan or SIMPLE IRA is similar to a SEP IRA but has a few different features. Employers with less than 100 employees can create a SIMPLE IRA account that allows employers and employees to contribute, unlike the SEP-IRA. Employers must either match dollar for dollar, each employee’s contribution up to 3 percent of the employee’s earnings, or contribute 2 percent of the annual wages with a 2020 limit of $285,000. Employees can contribute up to $13,500 in 2020, with more allowed if over 50 years of age. Distributions are taxed as they’re withdrawn like a Traditional IRA.
All of these different types of IRA accounts have other benefits and costs depending on each employer and employee’s financial situation. Realistically, a combination of multiple accounts and professional tax planning is recommended for any corporation or individual looking to maximize their income and savings for the future. The tax professionals at Nimrod Yaron & Co. are equipped to help you and your business today.
