Deciding to start an Individual Retirement Account (IRA) is a significant step.
When you run a business, it can be challenging to find time to learn how to save, and especially how to choose between traditional IRAs and Roth IRAs.
IRAs can be opened by anyone who works or has a working spouse, including business owners.
IRAs can help you increase the money you have available for retirement because you are allowed to invest the cash you put into them.
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Your investment options will typically include stocks, bonds, mutual funds, exchange-traded funds (ETFs) and CDs.
Often large brokerages will let you open an IRA for free and with no annual fee, but you must pay for each trade. Some brokerages do charge an annual fee but will waive it if you arrange automated deposits from your bank account. Many brokerages have a minimum deposit, such as $500 or $1,000, to open an IRA, but some don’t require one.
To save you time, here is a crib sheet looking at the major differences between traditional IRAs and Roth IRAs. By understanding the tax implications, income limits and withdrawal rules, you’ll be able to make the best choice for you.
1. Traditional IRAs Are Open to Just About Anyone Saving for Retirement. Roths Are a Little Trickier.
You can open a traditional IRA if you will be younger than 70½ at the year’s end, if you are working or receive long-term disability benefits. There are no income limits.
What about Roths? If you are married and file jointly, and your adjusted gross income is less than $193,000, you can open a Roth IRA. If you are filing separately but live with your spouse and your adjusted gross income is less than $10,000, you are eligible. If you are single and filing separately or are married but don’t live with your spouse, you can contribute to a Roth IRA if your adjusted gross income is less than $131,000. However, the benefits start to phase out at income limits below these maximums.
Many business people have several IRAs, including some of both kinds.
2. Traditional IRAs Give You a Tax Break on the Front End.
With a traditional IRA, you get a tax break when you put the money in and pay taxes on the withdrawal. Your earnings grow tax-free while they’re in the account.
3. Roth IRAs Give You a Tax Break on the Back End.
Roth IRAs differ from traditional IRAs in that you pay income taxes now on the money you invest in them. However, you pay no taxes when you withdraw the money. If you are in a lower tax bracket in retirement, this could make a Roth IRA advantageous to you. Just like in a traditional IRA, your money grows tax-free while it’s in the account.
4. There Are Contribution Limits, and They Apply to Both Kinds of Accounts.
You can save up to $5,500 per year, combined, in all your IRAs, or $6,500 if you are 50 and older.
5. You Can Contribute More, but There Will Be Tax Implications.
You can contribute more to a traditional IRA, but you won’t get a tax deduction. You are also allowed to make a non-deductible contribution to a traditional IRA and convert it to a Roth IRA. But check with your accountant first, because there are likely to be tax consequences.
6. You Can Take Your Money From a Traditional IRA Before Retirement, but You'll Owe Taxes and Maybe a Penalty.
If you withdraw money from your traditional IRA before age 59½, you might owe a 10 percent penalty on the distribution, plus whatever tax you’d normally pay on income. There are exceptions, such as for disabilities, first-time homebuyers and other circumstances.
7. You Can Treat a Roth IRA a Little Bit More Like an Emergency Fund.
If you are under 59½ years old, you may withdraw the exact amount of your Roth IRA contributions (not earnings) with no penalties. If you are over 59½, you may withdraw as much as you want so long as your Roth IRA has been open for at least five years. There are special exemptions for first-time home purchase and college expenses.
8. You Can Leave the Money in a Roth IRA for as Long as You Want.
While a traditional IRA requires you to start withdrawing money at age 70½, that’s not true with a Roth IRA. There are no required minimum distributions. That can make Roth IRAs a good option if you love running your business and plan to continue operating it well into retirement, delaying your need for income.
9. There Are Other Kinds of IRAs to Consider.
Simple IRAs are available to owners and employees of small businesses that don’t have a retirement plan in place, but there are contribution requirements for employers and employees. If you are self-employed, you might also want to look at SEP IRA as a kind of traditional IRA with higher contribution limits, so that you can contribute as much as 25 percent of your pay. That’s a significant benefit for small business owners.
Ultimately, there’s no right or wrong IRA for a business owner. The best one for you will reflect your unique plans for the future.