Traditional IRA Calculator
One of the easiest ways to save for your future along with getting some relief from the IRS is through an Individual Retirement Account (IRA). The calculator above permits you to enter your own details to get an idea of how much you could have saved by retirement in a Traditional, Roth, SEP or SIMPLE IRA compared to a standard brokerage or savings account. Below we look at what each account includes and the differences between accounts to help you decide what to invest in.
Traditional IRA
Traditional IRAs are funded with pre-tax contributions. This means that you can reduce your taxable income (within income limits and limits based on whether you have a workplace plan) when you make a contribution. His money will grow tax-deferred, meaning he won’t have to pay taxes on dividends, interest, or capital gains until the applicable taxes become due. However, when you do withdraw the money in retirement you will pay tax on every pound you take out as income. If you withdraw before age 59, you will have to pay an extra 10% tax on the amount you withdraw. As you turn in your early 70s, it will be made mandatory by the IRS to take minimum distributions. Traditional IRA will be chose by many savers because they can get a tax deduction whilst they are earning a higher amount of income (and therefore likely in a higher tax bracket) and pay less tax on the money in the future.
Roth IRA
A Roth IRA is the opposite of the Traditional IRA. Here you make after-tax contributions so you can’t claim the tax deduction. However, you will get tax free withdrawals on the money (including any growth) in retirement. A Roth IRA could be a great option, if you think you will be in a similar or higher tax bracket in the future, or just want a pot of money that you won’t pay any tax on. Roth IRA’s also don’t require minimum distributions whilst the original account holder is alive so the money will continue to grow. However, if you earn a high income, you’ll lose out on contributing. Roth IRA contributions will phase out once you reach certain income thresholds.
SEP IRA
For the self-employed and small business owners, a SEP IRA (Simplified Employee Pension) is designed. With this account only the employer makes contributions. The contribution limits are grounded on a percentage of compensation, so you’ll be able to contribute much more than you would in a standard IRA if you have a good year. It is quick to set up and does not require much administration which makes it more economical. If you have employees you will typically have to contribute the same percentage to their pay as you do to yourself. Many consultants, contractors and one person businesses like using a SEP IRA because it allows them to have significant tax delayed savings without having to employ someone to manage benefits.
SIMPLE IRA
A SIMPLE IRA (Savings Incentive Match Plan for Employees) is a good option for small businesses with up to 100 employees. Both the employee and employer can contribute here. The employee will make a contribution by deferring part of their pay. The employer has to make a contribution either by matching a percentage of the employee’s contributions or contribute a small amount to all employees. The contribution limits are lower when compared to a 401(k), but higher than a standard IRA. There’s also no perception testing, so it is a great option for a growing company wanting to offer real retirement benefits.
IRA Rollovers
A rollover is when you transfer your money from one retirement account to an IRA without paying tax. This is typically used when leaving a job and needing to move your old 401(k) into a new account. The best option is to do a direct rollover where the money is sent directly to your new custodian because no tax is withheld. Alternatively, you can do an indirect rollover and receive the cheque. However, the significant point you need to keep in mind is that you will only have 60 days to put the money into an IRA. If you fail to do this, it will be treated as a taxable distribution. If you’re under age 59 you may also pay an early withdrawal penalty. There is a limit on indirect rollovers between IRAs. The IRS will only allow you to do one every 12 months. However, there is no limit on transfers between custodians. As long as done correctly, your retirement savings will grow tax deferred (or tax free in a Roth).
Comparison to 401(k)s
Both IRAs and 401(k) s aim to help you save for retirement with tax benefits. However, a 401(k) is employer sponsored. They’ll typically have employer contributions, higher contribution limits and a limited number of investment options. Whilst an IRA is self-setup. Whilst you’ll have a lower contribution limit you’ll have many more investment options.
Traditional IRA
Typically you’ll have a lower contribution limit than a traditional 401(k). You’ll also not get any employer contributions as there isn’t an employer. However, you’ll have more control. You can choose your custodian, fee structure and have almost all of the public market to invest in instead of a few dozen funds. Many people will use both; they’ll contribute enough to get the full employer contribution and then contribute extra into a Traditional or Roth IRA.
SEP and SIMPLE IRA
If you’re a small business owner then a SEP or SIMPLE IRA is the low cost option compared to a 401(k). Although a 401(k) can have higher contribution limits and extra benefits such as loans or Roth 401(k)s, you will have to have plan documentation, discrimination testing and ongoing administration fees. A SEP or SIMPLE can typically be set up in one sitting and don’t have as much compliance. Many small employers will start with a SEP/SIMPLE IRA and move onto a full 401(k) as their business grows.
Investments Options in an IRA
One of the great benefits of an IRA is the amount of investment options available. A typical 401(k) will only have between 8-30 options that have been selected by the plan administrator. However, if you open an IRA with most major brokerages you’ll have access to almost all publicly traded stocks, bonds, ETFs and mutual funds. If you have a self-directed IRA you will have access to far more assets outside of Wall Street.
Active Investing in Individual Stocks or Similar Assets
Some people like to actively invest by choosing individual stocks, bonds or similar assets to invest in. This can be a great way to invest, however it will require more research and you will have to monitor your investments. This is best for people who like to monitor individual companies and are satisfied for their performance to vary significantly from the market.
Mutual or Index Funds
Most people will choose a mutual or index fund as this bundles together lots of different holdings to spread out your risk. You won’t have to do any research into individual investments. Index funds with low fees have become a popular option for retirement savings.
Robo-Advisors
Robo advisors will invest for you. You just have to answer a short questionnaire and an algorithm will be created and rebalance a diversified portfolio for you. This typically has a small annual fee. This is a great option for those who want hands off approach to their IRA.
Others
Many people invest in target date funds. These automatically change from stocks to bonds as you near your chosen retirement date. Some people will work with a traditional financial advisor. Others will use sector ETFs and bond funds to give them more control over their portfolio.
Self-Directed IRA
A self-directed IRA works in the same way as a Traditional/Roth IRA but it is held with a specialist custodian. This means you will have much more flexibility with your investments. You will be able to invest in assets such as property, private businesses and precious metals. However, there is more responsibility such as there won’t be a fund manager doing any due diligence for you and the IRS has strict rules regarding prohibited transactions. These can be more expensive to administer. They tend to be best for experienced investors who know what they want to invest in.