11.3 Individual Retirement Accounts (IRAs)

Individual Retirement Accounts (IRAs) are key tools for building a secure financial future. They offer tax advantages and flexibility, allowing you to save for retirement while potentially reducing your current tax burden.

There are several types of IRAs, each with unique features. Traditional and Roth IRAs are popular choices for individuals, while SEP and SIMPLE IRAs cater to self-employed people and small businesses. Understanding the rules and benefits of each can help you make smart retirement savings decisions.

Types of IRAs

Traditional and Roth IRAs

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• Traditional IRA allows tax-deductible contributions and tax-deferred growth
• Withdrawals from Traditional IRAs taxed as ordinary income in retirement
• Roth IRA contributions made with after-tax dollars
• Roth IRA withdrawals tax-free in retirement if certain conditions met
• Both Traditional and Roth IRAs have annual contribution limits ($6,000 for 2022,$7,000 if age 50 or older)
• Income limits may restrict eligibility for Roth IRA contributions or Traditional IRA tax deductions

Self-Employed and Small Business IRAs

• SEP IRA designed for self-employed individuals and small business owners
• SEP IRA contributions made by employer, up to 25% of employee's compensation or $61,000 for 2022
• SIMPLE IRA intended for small businesses with 100 or fewer employees
• SIMPLE IRA allows both employer and employee contributions
• Employee contribution limit for SIMPLE IRA $14,000 for 2022, with$3,000 catch-up for those 50 or older
• Employer must match employee contributions up to 3% of salary or make 2% non-elective contributions

Contribution and Withdrawal Rules

Contribution Limits and Tax Deductions

• IRA contribution limits vary by account type and change annually (Traditional and Roth: $6,000 for 2022)
• Catch-up contributions allow additional $1,000 for those 50 or older
• Traditional IRA contributions may be tax-deductible depending on income and workplace retirement plan coverage
• Roth IRA contributions not tax-deductible but grow tax-free
• SEP IRA contributions limited to lesser of 25% of compensation or $61,000 (2022)
• SIMPLE IRA employee contributions capped at $14,000 (2022), with$3,000 catch-up provision

Withdrawal Rules and Penalties

• Required Minimum Distributions (RMDs) apply to Traditional, SEP, and SIMPLE IRAs starting at age 72
• RMD amount calculated based on account balance and life expectancy
• Roth IRAs not subject to RMDs during the owner's lifetime
• Early withdrawals (before age 59½) from Traditional, SEP, and SIMPLE IRAs subject to 10% penalty
• SIMPLE IRA early withdrawals within first two years incur 25% penalty
• Exceptions to early withdrawal penalties include first-time home purchase ($10,000 lifetime limit) and qualified education expenses
• Roth IRA contributions can be withdrawn at any time without penalty, earnings subject to rules