Traditional, Roth, SIMPLE and SEP IRAs all offer tax advantages if you are saving and investing for retirement. Pretax contributions from you and your employer can be placed in SIMPLE and SEP IRAs. The traditional IRA contribution is made after-tax but allows you to deduct your contributions from your taxes, if you meet certain requirements. Roth contributions are made on an after-tax basis with no deductions.
SIMPLE and SEP IRAs
A SIMPLE IRA plan is designed for small businesses and companies. Companies can use the plan to make pretax contributions to IRA accounts for their owners and employees. These plans can only be used by companies with 100 employees or less who earned $5,000 or more in the previous calendar year. A SEP IRA operates similarly to the SIMPLE IRA in respect to pretax contributions, but has no limit on the size of the company that can use them. However, SEPs are more often used by self-employed individuals. If you're thinking about starting either of these plans, you should consult with your tax adviser about which one is right for you and your business. Withdrawals from these accounts at retirement will be taxed as ordinary income. Penalties apply for early withdrawal.
Traditional IRA Deductions
Qualifying for a full tax deduction for contributions to a traditional IRA will be based on your income if you have an employer-based retirement plan such as a 401(k). If you are covered by a retirement plan at work, your deduction for contributions to a traditional IRA may be partial based on your income and filing status. The schedules for these deductions may vary from year to year, so you should check with the Internal Revenue Service regarding the income level at which you can take a full or partial deduction. If you do not have a defined contribution plan through work, you can take a full tax deduction in most cases. If you have a spousal IRA, your deduction may be reduced based on your income. Here again, the deduction rules are subject to change, so you should check with the IRS about your eligibility. Currently, these rules are available in IRS Publication 590. As with SIMPLE and SEP IRAs, withdrawals from traditional IRA accounts at retirement will be taxed as ordinary income. Penalties apply for early withdrawal.
Getting a Tax Credit
With a traditional IRA, you may also be able to get a tax credit. The tax credit is based on your income and filing status. You also need to meet these requirements: your birthday must be before January 2, 1994, you can't be a full-time student and no other people, such as your parents, can take an exemption for you on their tax return in the tax year you are filing.
Roth IRA contributions are always made after-tax whether the funds come from you or your employer and are not deductible. However, you do not pay taxes on Roth withdrawals when you reach the IRS's designated retirement age.
Wayne Marks has more than 20 years of experience in finance, education, public relations and marketing in both New York City and Washington, D.C. He has worked for corporate and nonprofit organizations and holds a certificate from the Wharton School of Business.