When you planned your wedding, your retirement was probably one the last things on your mind, but planning for retirement early in your career can set your family up for greater financial freedom later in life. Contributing money to tax-advantaged retirement plans like individual retirement accounts is one of the best ways to save for retirement. Federal law establishes a few different types of IRAs. One type of IRA is not categorically better than another: choosing the right IRA depends on your personal financial situation and preferences.
A traditional IRA is the standard type that any individual is free to open with a financial institution like a bank or mutual fund company. A traditional IRA is very similar to a 401(k) plan: The money you contribute is tax deductible and your investments grow on a tax-deferred basis until you withdraw the money during retirement. With traditional IRAs, you incur a 10-percent early withdrawal penalty if you take funds out before age 59 1/2, and you must begin taking money out by age 70 1/2 at the latest.
A Roth IRA differs from a traditional IRA in that contributions are not tax deductible, but you don’t have pay taxes on your investment earnings, even when you withdraw the money during retirement. In addition, you can withdraw your Roth contributions without penalty, although you cannot withdraw investment gains before the age of 59 1/2 without penalty. With a Roth IRA, you don't have to withdraw money starting at age 70 1/2. The contribution limit is $5,000 a year for both traditional IRAs and Roth IRAs, which increases to $6,000 if you are age 50 or older.
Traditional vs. Roth
Traditional and Roth IRAs can both be attractive retirement plan options -- but if you and your spouse file joint tax returns and your income is greater than $179,000, you cannot contribute to a Roth IRA, so a traditional IRA is your only option. If you don't have access to an retirement plan through an employer, your traditional IRA contributions are tax deductible, regardless of your income level. If you do have access to a retirement plan at work, your tax deduction begins to phase out if your joint income is greater than $92,000. Since Roth IRA contributions are not taxed at the time of withdrawal, they can offer greater tax savings than traditional IRAs, but contributions are more costly because they are not tax deductible. If you can't afford to contribute the maximum amount, a traditional IRA may be your best option, since the tax deduction can make contributions easier on your budget. If know you can afford to make the full $5,000 contribution each year, you will end up with more money during retirement with a Roth, since your withdrawals are not taxed.
SIMPLE and SEP IRAs
SIMPLE and SEP IRAs are special types of accounts that are available to self-employed individuals and small businesses. According to CNN, a simplified employee pension IRA -- SEP -- lets you save 25 percent of income up to a maximum of $49,000 for yourself and your employees. A SIMPLE IRA is a plan designed to help employees save for retirement, and it forces employers to make contributions on behalf of employees. Employees themselves can contribute up to $11,500 a year to a SIMPLE IRA. If you are self-employed, a SEP IRA offers a way to contribute more to a retirement plan than traditional or Roth IRAs. Similarly, if you work for a small business and have access to a SIMPLE IRA, you can use the employer-offered IRA to contribute more toward retirement each year than is possible with traditional or Roth IRAs.
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