While 401(k) plans are well known by most investors through their workplace retirement plans, IRAs may not be. While the IRA was created several years before the 401(k), more workplace retirement plans offer 401(k) options than IRA options. Starting an IRA today often means doing it yourself, and the options available to you may seem complicated or overwhelming.
But investors who rely solely on a 401(k) and ignore their options to start an IRA could be shorting themselves when it comes to saving for retirement. You could be missing out on tens of thousands or even hundreds of thousands of dollars worth of potential retirement savings. Read on to learn more about IRAs and figure out which options might be best for you.
What Is an IRA?
An individual retirement account (IRA) is a type of retirement account established by the Employee Retirement Income Security Act of 1974 (ERISA). An IRA is one of many types of accounts that investors can use to invest for their retirement.
Types of IRAs
It’s important to understand that there are many different types of IRAs. Each has its own advantages and disadvantages, and not every type of IRA is available to every investor.
1. Traditional IRA
The traditional IRA (or Traditional IRA), sometimes still called a Regular IRA, is the type of IRA with which most people are familiar. A traditional IRA allows you to use pre-tax dollars from salary deductions and invest them in an IRA. Those gains accrue tax-free until you decide to take a distribution, at which time your distribution is taxed at ordinary income tax rates.
2. Roth IRA
Roth IRAs are a relatively recent development, and allow investors to invest post-tax dollars in an IRA. Those assets continue to make gains tax-free, and then are not taxed when you decide to take a distribution. Roth IRAs are often preferred by those who think that they will end up in a higher tax bracket in retirement than they are in right now.
Roth IRAs are also subject to different regulations regarding distribution penalties and required minimum distributions (RMDs) than traditional IRAs. With recent changes to IRA regulations to eliminate so-called “stretch IRAs,” there is speculation that Roth IRAs will grow in popularity because of the Roth IRA’s unique characteristics.
3. SEP IRA
SEP IRA stands for Simplified Employee Pension IRA. It’s a type of IRA that was developed to allow self-employed individuals and those who own small businesses to benefit from an IRA. In general, a SEP IRA is used by a small business owner who is either the sole employee or who employs very few employees. SEP IRAs allow significantly greater annual contributions than traditional IRAs, and can run well into the tens of thousands of dollars annually, versus the current $6,000 contribution limit for traditional IRAs.
4. SIMPLE IRA
SIMPLE IRA stands for Savings Incentive Match Plan for Employees IRA. It’s a specific IRA developed for small businesses with fewer than 100 employees, to allow those companies to offer their employees a tax-deferred retirement plan. SIMPLE IRA plans are normally cheaper to administer than a 401(k) plan, but often offer fewer investment options.
Contribution limits for a SIMPLE IRA are higher than for a traditional IRA but lower than for a 401(k). There are also rules for rollovers from SIMPLE IRAs that differ from those for other IRAs and tax-advantaged retirement accounts.
5. Self-Directed IRA
A self-directed IRA isn’t a separate type of IRA, but rather an IRA that allows you to invest in non-traditional assets such as precious metals, real estate, or agricultural commodities, assets that you might not have access to through a conventional brokerage. A gold IRA, in which you invest in physical gold coins and bars, is one example of a self-directed IRA.
With a self-directed IRA, you the account owner are in control of your investments, and you determine which assets your self-directed IRA invests in. Aside from a few asset types such as collectibles that are explicitly forbidden under federal law, your investment options in a self-directed IRA are nearly unlimited.
Self-directed IRAs can be set up either as a traditional IRA, using pre-tax dollars, or as a Roth IRA, using post-tax dollars. You can also transfer or roll over assets from a traditional IRA, 401(k), or similar account into a Roth self-directed IRA by doing a Roth conversion.
6. Rollover IRA
A rollover IRA isn’t a separate type of IRA either, but rather an IRA that is funded by rolling over funds from another retirement account such as a 401(k) into an IRA. Under certain circumstances, assets from your rollover IRA can be moved back into the account they first came from. That would allow you to move assets out of stock funds held in a 401(k) into an IRA when stock market conditions deteriorate, then move them back into a 401(k) in the future if stocks start to perform better.
Rollover IRAs are a popular method of opening self-directed IRAs such as a gold IRA. If you have existing retirement accounts, you can fund a gold IRA through a rollover or transfer from existing 401(k), IRA, TSP, or similar retirement accounts. That allows you to protect your assets with an investment in physical gold coins or bars, while still enjoying the same tax advantages as your existing retirement accounts.
IRA Ground Rules
There are a few additional rules that you need to be aware of when investing in an IRA. Annual contribution limits for 2021 are $6,000 for traditional and Roth IRAs, with those over the age of 50 being able to invest an extra $1,000 “catch up” contribution each year. SEP and SIMPLE IRAs have different contribution limits. Since they’re relatively uncommon, they won’t be covered here, but if you have a SEP IRA or SIMPLE IRA, you’ll want to consult your tax advisor or financial advisor to go over all the rules and regulations and learn how they differ from traditional or Roth IRAs.
Distributions taken before age 59 ½ from a traditional IRA are subject not only to income taxes, but also to an additional 10% penalty. Distributions from a Roth IRA are not subject to penalty if you’re withdrawing contributions, but can incur a 10% penalty if you withdraw earnings too early. Traditional IRAs require you to take required minimum distributions (RMDs) at age 72, while there are no RMDs for Roth IRAs during the lifetime of the original account owner.
Regulations surrounding IRAs can be quite extensive, so you’ll want to consult your tax advisor and financial advisor to make sure you’re complying with everything you need to. But if you have a 401(k) and not an IRA, you may want to think about diversifying your retirement savings options. And if you have funds in a 401(k), IRA, or TSP account that you want to protect against market volatility, you may want to think about investing in a self-directed IRA such as a gold IRA to make sure that your retirement assets remain sheltered and protected against the possibility of a stock market crash.
Have questions about self-directed IRAs or gold IRAs? Call the experts at Goldco today and learn more about how a self-directed IRA can help protect your retirement.