What’s an IRA?

What type of IRA suits you? Here is a list of the most popular types of IRAs, their specific purposes, and their annual contribution limits.

6 min read

An IRA is one of the popular retirement planning vehicles that taxpayers use to save for retirement. Investing in an IRA allows you to contribute pre-tax or post-tax dollars to your retirement account, depending on when you want to pay taxes. You can open a traditional IRA and let your money grow tax-deferred, or open a Roth 401(k) and let your money grow tax-free.

An IRA is a tax-advantaged retirement account that you can use to save for your retirement. It is similar to a 401(k), but it is not tied to specific employers. If you have earned income, you can open an IRA account with a bank, broker-dealers, or other authorized custodians.  There are various types of IRAs that you can open, including traditional IRAs, Roth IRAs, SEP IRAs, SIMPLE IRAs, and even self-directed IRAs.

What’s an IRA?

An IRA is a retirement savings account can workers can use to save and invest in retirement. Unlike a 401(k), an IRA allows anyone with an earned income to open an IRA account and start saving for retirement. You can open an IRA with a brokerage, commercial bank, or investment bank.

One of the key advantages of an IRA is the wider selection of investment options. You can invest in bonds, REITs, ETFs, stocks, mutual funds, etc. The retirement saver makes all investment decisions. If you have a traditional 401(k), you will be required to contribute up to $6000 per year in 2021 and an additional $1000 if you are older than 50. You will only pay taxes when you take a distribution in retirement.

What’s a Roth IRA?

A Roth IRA allows retirement savers to make after-tax contributions so that future distributions will be tax-free. It requires retirement savers to pay taxes upfront when making contributions so that the money will grow tax-free prior to retirement. A Roth IRA is a good choice if you are young, or if you expect your income to increase in the future.

If you have a 401(k) or traditional IRA, you can rollover the money into a Roth IRA to enjoy the benefits of this account. There is no limit on how much retirement savings you can rollover to a Roth IRA. For 2021, you can set aside up to $6,000 per year, or $7000 if you are above age 50. A unique advantage of Roth IRA over 401(k) is that you won’t be required to take the required minimum distributions when you attain age 72.

What’s a rollover IRA?

A rollover IRA is a type of IRA that allows the transfer of assets from an employer-sponsored retirement plan into an IRA. This account allows retirement savers to retain the tax-deferred status of the old account by moving the retirement assets to a new account without paying income taxes or early distribution penalties. Common employer-sponsored retirement accounts that can be rolled over to an IRA include 401(k) and 403(b). A rollover IRA allows employees to invest in a wide pool of investments such as stocks, bonds, mutual funds, CDs, and ETFs.

What’s a SEP IRA?

If you are self-employed or own a small business, you can use a Simplified Employee Pension (SEP-IRA) to save for retirement. A SEP IRA is easy to set up, and the employer can decide how much to contribute to each employee's account. Usually, a SEP IRA allows higher contributions than a traditional IRA due to its ability to receive employer contributions.

SEP IRAs encourage small businesses that would not otherwise set up employer-sponsored plans for their employees. This type of IRA is available to partnerships, sole proprietorships, and corporations.

What’s a simple IRA?

A SIMPLE IRA is available to SMEs with 100 or fewer employees. It allows employees to stash a portion of their pre-tax income into an IRA, and get mandatory employer contributions. In 2020 and 2021, employee contribution limits are capped at $13,500 per year and an additional $3,500 in catch-up contributions for those who are age 50 or older.

What’s a backdoor Roth IRA?

If your income exceeds the IRS-sanctioned limits, you may consider a Roth conversion strategy known as backdoor Roth IRA. This strategy allows you to convert a traditional IRA to Roth IRA. Although a backdoor Roth IRA is not an official type of IRA, it is a legal way to get around income limits that restrict certain taxpayers with high incomes from contributing to a Roth IRA.

For 2021, the IRS allows Roth IRA contributions for individuals with modified adjusted gross income below $208,000 for taxpayers who are married filing jointly, or $140,000 for single filers.

What’s a mega backdoor Roth IRA?

A mega backdoor Roth IRA allows people with high incomes use to move massive amounts of money into a Roth IRA. You can use this investing strategy to save an additional $38,500 in a Roth IRA per year. This strategy works if your employer allows in-service withdrawals and after-tax contributions. A 401(k) allows taxpayers to contribute up to $58,000 in 2021, or $64,500 if you are age 50 or older.

What’s a self-directed IRA?

A self-directed IRA is a type of IRA that holds alternative investments that may be prohibited in a traditional IRA. For example, a self-directed IRA may allow investors to invest in real estate, cryptocurrencies, livestock, precious metals, etc. The account holder manages the self-directed IRA directly, hence the name “self-directed”. Although a self-directed IRA could offer better returns and achieve diversification, it also presents more risk to investors.

What’s a beneficiary IRA?

A beneficiary IRA is an IRA that is set up with the goal of going to someone (a beneficiary) after the account owner’s death. This term may also be used to refer to an IRA account that is set up when a beneficiary inherits an IRA. A portion of the inherited IRA may be distributed to this account. The beneficiary has the option of keeping the money in the account or rolling them over into their account.

The rules of how inherited IRAs are treated depend on whether you are the spouse of the deceased account owner or a non-spouse beneficiary. For example, if you are the spouse, you can rollover the money into your IRA or spread out the distributions over your lifetime. However, if you inherited your parent's IRA, you must take the full payout within 10 years after the account owner's death.

What’s an education IRA?

An education IRA is a savings account that parents and guardians can use to make non-deductible contributions for their child’s educational expenses up to college. It is formally known as Coverdell Education Savings Account. The education IRA can be used to cover tuition, books, uniforms, etc. These funds are withdrawn tax-free when the child needs the money for educational expenses.

You can open an education IRA on behalf of a child who is below 18. The yearly contributions are capped at $2000 per child per year, and the savings grow tax-free until when you take a distribution for educational purposes.

What’s a real estate IRA?

This is an IRA that invests heavily in real estate. When using an IRA to invest in rental properties, multifamily homes, commercial property, and other real estate properties, all incomes and gains earned are tax-deferred until when you make a withdrawal. However, if you are using a Roth IRA to invest in real estate, the incomes and gains will be tax-free, since you pay taxes when you contribute to the account. With a real estate IRA, the account owner directly picks, buys, and sells the real estate investments in their portfolio.

What’s a gold IRA?

A gold IRA is an IRA that invests in physical gold and other precious metals. You can open a gold IRA with a broker-dealer, and you can set up a pre-tax or post-tax dollar account. A gold IRA carries higher fees than a regular IRA due to the cost of buying and holding precious metals, and it must be maintained separately from a traditional IRA. However, its contribution limits and distribution rules are the same as a traditional IRA.

What’s a Keogh IRA?

A Keogh is a retirement plan for unincorporated businesses (sole proprietorships and partnerships) and self-employed individuals. Contributions to a Keogh plan are made with pre-tax dollars, and the retirement savings grow tax-deferred until when the account holder takes a distribution. It has a higher contribution limit than an IRA and 401(k), and the qualified defined-contribution plans allow individuals to contribute up to $58,000 in 2021 or $230,000 for qualified defined-benefit plans in the same period. The retirement contributions are invested in different types of securities such as stocks, bonds, annuities, and certificates of deposit.

What’s a nondeductible IRA?

A non-deductible IRA is an IRA that is funded with post-tax dollars, meaning that the contributions grow tax-free. Most taxpayers turn to non-deductible IRA because their income is too high to make contributions to a Roth IRA. For any contributions you make to a non-deductible IRA, you will need to fill Form 8606 when filing your federal tax return. Any investment earnings you make will be tax-deferred until when you withdrawal funds in retirement.

What’s IRA BDA?

An IRA BDA is an IRA that you receive if you are a named beneficiary of another person. It is commonly referred to as an inherited IRA. An IRA BDA has different rules from a traditional IRA. Your options with the inherited IRA depend on your relationship with the deceased account owner. If you are the spouse, you can treat the inherited IRA as your own, or rollover over the inherited IRA into an IRA. The Secures Act also introduced new rules for non-spouse beneficiaries, and the IRS requires these beneficiaries to withdraw all the money in the inherited IRA within 10 years from the account owner's death.