Are you self-employed or run a small business?

If so, you’re probably looking for a way to save up some more money for your retirement or perhaps a way to get a tax break – and with so many different kinds of saving and retirement accounts out there, searching for the right one to invest in can take some time.

But here is an account that could help you save money towards retirement – an IRA. To learn more about IRAs and how they can help you in the future, this article will answer some basic questions about IRAs.

What Is An IRA

IRA stands for ‘Individual Retirement Account’, and it is an individual savings account that uses tax advantages so you can save and invest in the long-term.

This may sound similar to a 401(k) account but the disadvantage to a 401(k) plan is that it can only be obtained through an employer. An IRA can be opened by anyone with an earned income so you can enjoy tax benefits and save long term without having to rely on another party. The tax benefits that come with an Individual Retirement Account allow your savings to grow or compound more quickly than in a taxable account, further benefiting you in your retirement.

There are many different types of IRA accounts, each with their own unique advantages, as well as rules regulating eligibility and taxation. Here are some of the various kinds of IRAs you will be offered when you decide to open one:

Traditional IRA
Roth IRA
SEP IRA
SIMPLE IRA

The limitations to an IRA include an annual income limitation for deducting contributions to traditional and Roth IRAs.  Also, the money within an IRA cannot be withdrawn before the age of 59 years and 6 months without incurring a tax penalty of ten percent of the amount you wish to withdraw. This is a retirement fund, and so withdrawing money before you reach retirement age can cost you.

To open an IRA, you can just visit your local bank or obtain one through an investment company, an online brokerage or a personal broker. Each will offer you a wide range of IRA accounts, each made up of different kinds of investments including mutual funds, stocks, bonds, and potentially even more.

Why You Should Invest In An IRA

The general consensus on retiring is that you may need to have saved up to 85% of your pre-retirement income to enjoy your retirement in comfort. The issue with this is that employer sponsored saving plans, like the aforementioned 401(k), might not be enough for you to reach this level of savings before you retire. Thankfully, you can contribute to both a 401(k) account and an IRA, but IRAs often come with even more benefits.

An IRA allows you to enhance your current savings with your employer sponsored retirement plan, while also allowing you to gain access to a wider range of investment choices.

IRA investors can choose from a wide range of financial products, including stocks, bonds and even exchange-traded funds (ETFs). There are even self-directed IRAs that allow IRA investors to call the shots. These give you access to even more types of investments, including real estate and commodities, giving you full access and allowing you to make all the decisions regarding your money and account.

Which IRA Is Best For You

As mentioned earlier, there are several different types of IRAs, each with their own benefits and limitations. Below, we will list these different types, and you can decide which one would work best for you and your savings.

Traditional IRAs give you an immediate tax break. You can deduct your entire contribution for the tax year, up to the limit as long as you and your spouse don’t have a 401(k) account or any other employer sponsored retirement plan. If one of you does have another retirement account the deduction may be reduced or eliminated. Also, a traditional IRA grows tax-deferred, which means that you will pay no taxes on the money within your fund but once you begin to withdraw the money during retirement, you will pay ordinary income tax on the entire balance of your account. You must start taking required minimum distributions (RMDs) by April 1st of the year after you turn 72.

A Roth IRA works differently. Unlike with a traditional IRA, you do not get that upfront tax break – but if the account is at least five years old and you are older than 59 and six months, then withdrawals are tax free. There are no RMDs as you already have paid the tax, so you are free to do whatever you want with your money. You can take it out whenever you want or leave it for your family to inherit tax free once you are gone. However, Roth IRAs do come with an income limit so check to see if you are eligible before you apply for a Roth IRA.

These two types of IRAs are the most basic ones you are able to get. The next two are designed to help people in more specific circumstances, like business owners and entrepreneurs.

Simplified Employee Pension IRA (shorted to SEP IRA) is an IRA that is established by either an employer or a self-employed individual. The employer is allowed a tax deduction for the contributions they make to  SEP IRA and can make discretionary contributions to each eligible employee’s plan. SEP IRAs often have a higher annual contribution limit compared to standard IRAs. The reason why SEP IRAs are so attractive to business owners is because they do not come with the operating costs as other employer sponsored retirement plans do, and employers can skip contributing when business is down for the year.

Finally, a SIMPLE IRA is also an IRA intended for small businesses and self employed individuals that follows the same tax withdrawals rules as the traditional IRA. However, unlike a SEP IRA, the SIMPLE IRA allows employees to make their own contributions to their account and the employer is also required to make contributions. SIMPLE stands for ‘Savings Incentive Match Plan for Employees’.

How To Maximize Your IRA

If you want the absolute most out of your IRA, then consider these tips to completely maximize your savings:

Start saving as soon as possible, even if you cannot contribute the maximum amount. This is a given for any kind of savings account – the sooner you start saving for retirement, the more you will have to live comfortably.

Contribute your money either early in the year or in monthly installments. This should be done so you get the best compounding effects. The longer your money has to compound, then the larger your savings will get.

As your income increases, consider changing your traditional IRA to a Roth IRA.

Conclusion

IRAs are increasingly popular as they allow people to use tax breaks to increase their savings. You can contribute at any time (although the earlier the better) and with all the different kinds of IRAs, you can choose one with the right tax advantages to suit you. There are multiple investment options available for opening an IRA, and you get to have complete control over your account, especially when compared to other employer sponsored retirement plans and 401(k) accounts.

So if you are wondering what your best options are to maximize your savings for when you retire, it might be a good idea to consider opening an IRA account.