As is the case with most financial products, there are various types of IRAs available to choose from. Traditional IRA, Roth IRA, SIMPLE, SEP, Rollover, spousal IRA, SDIRA, or SARSEPs – the list goes on and feels overwhelmingly long on a first look. Despite their similarities, the various types have significant differences.
Note that self-directed IRAs are a template that can be applied to most IRA variants. Self-directed accounts allow you to put your money into a wide variety of alternative investment vehicles that aren't available to non-self-directed IRAs.
In the vast field of IRAs, there are four subtypes which are most popular with investors and future retirees. The other types are usually less popular because they serve more niche interests.
The Traditional IRA – The Old Reliable
Regarded as the "biggest tax break in history", the traditional IRA has been popular since its institution in the mid-1970s. The only prerequisite for setting it up is a sufficient, steady income. A traditional IRA's biggest draw is that IRA contributions are tax-deductible.
Since 2021, IRA owners can put a maximum of $6,000 into their accounts. If you're over 50 years old, the contribution limit increases to $7,000.
But there are limiting factors when it comes to setting up a traditional IRA. The Internal Revenue Service (IRS) has drawn up a set of rules concerning deductions based on your modified adjusted gross income (MAGI). They distinguish between married couples who file for taxes separately or jointly as well as singles. Also, these rules can be subject to annual changes, which you can get detailed information on at the IRS itself.
Withdrawals from a traditional IRA are included in your gross income, from which federal income tax gets drawn. This procedure seeks to equalize the tax-deferred IRA contribution. Meanwhile, Roth IRAs have tax-free qualified withdrawals. As the owner of a traditional IRA, you are allowed to switch from a traditional to a Roth IRA. But this change can only occur once, and the decision is irreversible.
Initially created as an update for the traditional IRA, the Roth IRA has become a popular alternative to its predecessor. The retirement savings in the account can consist of various investment vehicles such as mutual funds, bonds, or common stocks. The IRS states specific rules for filing and eligibility for a Roth IRA. This account type's main benefit is its unique tax structure:
- Qualified withdrawals from a Roth IRA are tax-free.
- Growth in the retirement account's savings is tax-free.
These two factors are responsible for the high popularity of the Roth IRA and the shorter list of restrictions on possible investments made with the savings in the account. Also, distributions from this IRA type don't increase your adjusted gross income. Contribution limits are the same as with a traditional IRA, while all contributions are non-deductible.
Only ten years after the Roth IRA was established as an alternative retirement account type, 50 million taxpayers had already invested $3.3 trillion in their accounts.
Another benefit is the lack of Required Minimum Distributions (RMD) with a Roth IRA. While you have to make withdrawals from a traditional IRA once you've reached 72 years of age, there is no such rule for Roth IRAs.
SEP is an acronym for "simplified employee pension". Thus, SEP IRAs are open primarily to a specific group of future retirees:
- small-business owners
- independent contractors
The same rules that apply to withdrawing from a traditional IRA also apply for withdrawing from a SEP IRA. Business owners are allowed to open accounts of this type for their employees. But these accounts stay employer-provided for their lifetime, which means the beneficiaries can't contribute to their account. Also, withdrawing funds is subject to taxation by the IRS.
Another option for self-employed individuals and small businesses is the SIMPLE IRA. This type also follows the rules applicable to traditional IRAs. The difference lies in who is allowed to contribute. Employer and employee can both make contributions to the individual retirement account, and the employer is even required to do so.
To be precise: SIMPLE is an acronym for "savings incentive match plan for employees", describing the nature of this IRA subtype.
As of 2022, the contribution limit for employees is $14,000, and the catch-up is limited at $3,000 for workers aged 50 or older with a freshly set up account.
The funds placed in your retirement plan can be used for investments. Limiting factors for possible investments in your financial plan are IRS limitations on the one hand and limitations set up by your provider on the other hand. To achieve your financial goals by investing the funds in your IRA account, you have to ask yourself three important questions:
- How do you want to invest?
- How do you cope with risk?
- What is your time horizon?
The first question tells you which investment vehicles you might be interested in. You can choose from a wide array of financial products like ETFs, mutual funds, or quant hedge funds with CARL. As is the case with any investment, but particularly with your retirement plan, risk plays a significant role. While higher risk usually means higher-yielding returns, you must be able to live with the volatility investing – the possibility of an investment loss. The last question is about the time frame: How long do you plan to invest in a particular investment instrument before retiring? For some financial products, such as ETFs, longer time frames are beneficial, while others, such as stocks, may be chosen as short-term stock investments.
What Are Viable Investment Options?
Various products can be considered viable investment options for your retirement savings; among these are ETFs, stocks, mutual funds, bonds, or CARL quant hedge fund strategies. Investing in real estate isn't prohibited by law as an option, but many providers don't allow it based on their own set of rules for setting up an IRA account. In general, self-directed IRAs have fewer restrictions on which investment opportunities you can take advantage of.
CARL offers you a perfect package for investing: an easily accessible, powerful app, sophisticated quant hedge fund strategies with a low entry barrier, a minimum investment of only $20,000, and the option of setting up a self-directed IRA. Using CARL to achieve your financial goals means you can benefit from 15 %+ targeted returns, high liquidity, and realtime performance tracking features.
The IRS has ruled that two assets are not open for investing via your IRA: collectibles and life insurance. If you do choose to invest in collectibles, you are subject to additional taxes up to 10% on early distributions. We have compiled a partial list of examples that fall into the collectible category:
Bullion made of gold and other precious metals are also filed as collectibles by IRA statues.
Using an individual retirement account as a baseline to make provisions for when you retire is a great start. Using those savings to invest and grow your retirement income is better. Investing these funds with CARL is the cherry on top. Get in touch with CARL to find out if you are an accredited investor, set up an account, and start investing today to grow your wealth to enjoy your time as a retiree.