6 of the Most Common Financial Situations and the Ideal IRA for Each

6 of the Most Common Financial Situations and the Ideal IRA for Each

While the most popular vehicle for retirement savings is a 401(k), not everyone has access to this sort of employer-sponsored account. Or if they do have a 401(k), they may want to open a second tax-advantaged account. A great option is an individual retirement account (IRA), which operates much like a 401(k).

With this type of plan, you can invest money today and let it grow without taxes. Income tax is only due during withdrawals in retirement. IRAs offer some benefits over a 401(k), especially in terms of the types of investments available. There are generally only a few options available through a 401(k), but the full gamut of retirements can be secured through an IRA.

Importantly, many different types of IRAs are available depending on individual circumstances. Some common financial situations and the ideal IRA for them are discussed below.

1. Currently in a high tax bracket

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The most basic IRA is the traditional IRA. With a traditional IRA, you contribute pre-tax dollars to the account. Since the account is not employer-sponsored, you cannot get direct-payroll deductions. Instead, you can deduct up to about $6,000 annually, or $7,000 if you are 50 or older, from your taxes. The exact deduction limit depends on income and filing status. This upfront deduction can help you fall into a lower tax bracket right now and defer the taxes until retirement, when you will presumably be in a lower tax bracket. Investment earnings in the account are protected from taxation. This type of IRA is very similar to a 401(k).

2. Earning less now than in the future

A Roth IRA is a great choice if you expect to earn more money in the future. With this account, you contribute dollars that have already been taxed, and you can make tax-free withdrawals during retirement. Investments grow without any sort of taxation in the interim.

The other unique thing about a Roth IRA is that you can withdraw contributions at any time, although not the interest earnings. Eligibility for a Roth IRA is based on income, and higher earners may not qualify. However, for people who earn less now, it is a great way to pay low taxes now and then withdraw tax-free later, when taxes would likely be higher. The account is also good for people who may need to make withdrawals before retirement. However, it is best not to touch the account, if possible.

3. Self-employed with no employees

If you are self-employed without any employees, you are eligible for a SEP IRA. You can open a SEP IRA when you have just a few employees, but you will be required to contribute to their plans in the same proportion of salary as you do your own.

For many people with this account, it is the primary savings vehicle, so contribution limits are up to $57,000 per year. Contributions cannot account for more than 25 percent of total compensation. Unfortunately, no Roth version of the SEP IRA exists, but the upfront tax advantages still exist, as all contributions are tax deductible.

4. Dependent on a spouse’s income


Some people who have no income of their own may depend on a spouse’s salary. These individuals can still set up an account known as a spousal IRA, which can be funded by the spouse’s income. The assets legally belong to the account holder. As there is no joint IRA, this is a good way to boost retirement savings for couples.

The contribution limit for this account will be the same as that of the working spouse, but opening both would essentially let couples double their retirement savings. The tax advantages work similarly to a traditional IRA.

5. Working for or own a small company

If you work for or own a small company with fewer than 100 employees, you may not have access to a 401(k). A similar option is a SIMPLE IRA. SIMPLE, which stands for Savings Incentive Match Plan for Employees, requires a match. The contribution limits are set at $13,500, which is $6,000 less than that of a 401(k). People 50 or older can make catch-up contributions totaling $3,000.

Employees with access to a SIMPLE IRA should take advantage, as it basically means free money from their employers through the match. Self-employed individuals can open a SIMPLE IRA in addition to a SEP IRA, but the latter has much higher contribution limits and is therefore generally more favorable. The tax advantages between the accounts are very similar, however.

6. Ineligible for other IRAs

Some individuals may be in the position of not being eligible for any of the IRAs on this list because of personal circumstances ranging from employment status to total earnings. If this applies to you, you can still opt for a nondeductible IRA. As the name implies, the account does not offer the same tax breaks as other IRAs on the list.

You will need to contribute post-tax dollars and then you will still be subject to income tax upon withdrawal. However, the money in the account is still allowed to grow without taxation, which is an advantage over more traditional retirement accounts. The taxes paid upon withdrawal are only on the earnings since taxes have already been paid on contributions. This account only makes sense if you have maxed out contributions to other types of retirement accounts and are ineligible for any other type of IRA.