Please note: This article may contain outdated information about RMDs and retirement accounts due to the SECURE Act 2.0, a law governing retirement savings (e.g., the age at which individuals must begin taking required minimum distributions (RMDs) from their retirement account will change from 72 to 73 beginning January 1, 2023). For more information about the SECURE Act 2.0, please read this article or speak with your financial consultant. (1222-2NLK)
Individual retirement accounts (IRAs) are personal retirement savings plans that offer tax benefits and a range of investment options. Many investors use IRAs as their main source of saving for retirement. And even those who have access to employer-sponsored plans, such as a 401(k) or 403(b), still tap IRA tax advantages to boost their savings and add flexibility to their portfolio.
"After you've contributed up to the employer match in your employer-sponsored plan, an IRA may be the next best way to save for retirement," says Rob Williams, managing director of financial planning, retirement income, and wealth management for the Schwab Center for Financial Research. "IRAs may offer a wider range of investment options than your 401(k), such as individual stocks or bonds, if that’s your preference."
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Three main types of IRAs
It's important to know there are different types of IRAs, and that each type has different contribution, withdrawal, and tax rules. Rob says, "Which IRA is right for you will depend on a number of things, such as your income, whether you prefer potential tax savings now or in retirement, how required minimum distributions (RMDs) fit into your long-term plan, and whether you expect to be in a higher or lower tax bracket in retirement."
The three most common types of IRAs are traditional IRAs, Roth IRAs, and rollover IRAs. With a traditional IRA, contributions may be tax-deductible, meaning you could get a tax break up front. You’ll have to pay income tax on your traditional IRA savings when you start making withdrawals in retirement, and you’ll be required to take required minimum distributions (RMDs) each year starting at age 72. Anyone with earned income can contribute to a Traditional IRA.
Roth IRAs treat taxes differently. Instead of receiving an immediate tax benefit, you contribute after-tax dollars (income you’ve already paid taxes on). But your money grows tax-free and qualified withdrawals are tax-free in retirement. Roth IRAs aren't subject to RMDs, so you can leave the money in your account as long as you choose or leave it to your heirs. But your income must fall below a certain limit to contribute.
A rollover IRA, by contrast, is an account that allows you to move funds from your old employer-sponsored retirement plan into an IRA. "Rolling over" your savings in this way may allow you to preserve the tax-deferred status of your retirement assets without paying current taxes or early withdrawal penalties at the time of transfer. The specific tax benefits, as well as whether you’ll be subject to RMDs, will depend on the type of IRA you roll into—usually a traditional or Roth IRA.
Traditional, Roth, and Rollover IRAs
- IRA Type
- How much can I contribute?
- What is taxed?
- What is the tax benefit?
- Do RMDs apply?
IRA TypeTraditional>How much can I contribute?In 2022, $6,000 per year across all of your IRAs, or $7,000 if you’re 50 or older.>What is taxed?You’ll owe ordinary income tax on withdrawals, including RMDs.>What is the tax benefit?Contributions are generally tax deductible, but the amount you can deduct depends on your income.>Do RMDs apply?Yes, you’ll have to start taking RMDs starting at age 72.>
IRA TypeRoth>How much can I contribute?Same as above. But your income must fall under a certain amount to contribute to a Roth IRA.>What is taxed?Contributions are made with after-tax dollars (income you’ve already paid taxes on).>What is the tax benefit?Withdrawals are tax-free if you meet certain requirements.>Do RMDs apply?No, you won’t have to take RMDs.>
IRA TypeRollover>How much can I contribute?Regular IRA contribution limits apply. But you can roll over all assets in your employer plan one time.>What is taxed?Tax and RMD rules depend on the type of IRA you choose for your rollover—for example, a traditional or Roth IRA.>What is the tax benefit?Tax and RMD rules depend on the type of IRA you choose for your rollover—for example, a traditional or Roth IRA.>Do RMDs apply?Tax and RMD rules depend on the type of IRA you choose for your rollover—for example, a traditional or Roth IRA.>
Other types of IRAs
In addition to the three types of IRAs above, there are others you may have access to:
- SIMPLE IRA: A Savings Investment Match Plan for Employees is a low-cost retirement plan for self-employed individuals and small businesses with 100 or fewer employees. Employers can save for their own retirement and make contributions for employees. Employees can also contribute.
- SEP IRA: A Simplified Employee Pension plan is another way for self-employed individuals and business owners to set up a retirement savings plan for themselves and their employees. These accounts are funded by the employer, and contribution limits are higher than other types of IRAs.
- Inherited IRA: These accounts – also known as Beneficiary IRAs –are opened when someone inherits a traditional or Roth IRA after the death of the original owner.
- Custodial IRA: Any parent, grandparent, or other custodian can open a traditional IRA or Roth IRA for a minor who has earned income for the year. The minor assumes ownership of the account when they reach the age of adulthood in their state of residency.
- Spousal IRA: You usually have to have earned income to open and fund an IRA, but not with a spousal IRA. This plan allows the working spouse to fund a traditional IRA or Roth IRA for a spouse who does not have earned income. To qualify, you must file a joint tax return.
Traditional IRA withdrawals are subject to ordinary income tax and prior to age 59½ may be subject to a 10% federal tax penalty.
If you take a distribution of Roth IRA earnings before you reach age 59½ and before the account is five years old, the earnings may be subject to taxes and a 10% federal tax penalty.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for their own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.
A rollover of retirement plan assets to an IRA is not your only option. Carefully consider all of your available options which may include but not be limited to keeping your assets in your former employer's plan; rolling over assets to a new employer's plan; or taking a cash distribution (taxes and possible withdrawal penalties may apply). Prior to a decision, be sure to understand the benefits and limitations of your available options and consider factors such as differences in investment related expenses, plan or account fees, available investment options, distribution options, legal and creditor protections, the availability of loan provisions, tax treatment, and other concerns specific to your individual circumstances.0522-25ZF