Types of Retirement Plans:
You probably heard of a Traditional and a Roth IRA. You might not know there are different types of IRAs.
- Pre-tax accounts include Traditional, SEP and SIMPLE IRAs.
- Roth IRAs are after-tax accounts.
- 401k’s can hold both pre-tax and after-tax funds.
- Inherited IRAs retain the tax basis of the account when it was set up by the original account holder.
When making a pre-tax contribution, typically you do not pay taxes on that contribution. There are income limits for Traditional IRAs to be eligible in writing off the contribution. For example, if you earned $100,000 and make a $6,000 pre-tax contribution, you would pay taxes on $94,000. Check with your tax professional to determine your ability to deduct contributions.
When you make an after-tax contribution, you pay taxes on that contribution before it hits your account. If you earned $100,000 and then make a $6,000 Roth contribution, you pay taxes on $100,000.
Be aware there are income limits to being eligible to making a Roth contribution.
In IRS Publication 590 you can read about the income limits for writing off a Traditional IRA contribution and being eligible in making a Roth IRA Contribution.
401ks do not have income limits for making Roth contributions and being able to write off pre-tax contributions. Again, check with your tax professional when it comes to calculating your 401(k) contribution. You are eligible to contribute the lesser of 25% of your income or $58,000 for 2021.
You can learn more about Contributions on the uDirect website.
The profits of a pre-tax account grow tax deferred. You will pay personal income taxes when you take a distribution from the IRA. You must be over 59 ½ to avoid a 10% early distribution penalty. At 72, you start taking Required Minimum Distributions (RMDs).
The profits of a Roth IRA grow tax exempt when you take distributions, and as a result, the Roth is an extremely popular type of retirement plan. The Roth must be opened for over five years, and you must be over 59 ½ for the distributions to be penalty-free. Otherwise, you pay a 10% early-distribution penalty.
uDirect IRA Services is happy to discuss your Self-Directed IRA/401k questions. Call us at (866) 446-7454 or by email at info@uDirectIRA.com.