IRA Options: How to Determine Which IRA is Right for You

Individual retirement accounts (IRAs) are a financial vehicle designed to help American workers save for their retirement. While these accounts are just one type of investment and savings solution that can be used to achieve retirement goals, they’re an important fixture for many consumers. IRAs come in a few different shapes and sizes, all of which offer different benefits to consumers.

If you’re looking to open an account that puts money toward retirement, an IRA is often a great place to start. Before you set up your own IRA, though, you’ll want to review your options and figure out which account type best suits your savings goals and your current financial situation.

Here’s a look at the different IRA options and what makes each one unique.

Traditional IRA

The most common type of IRA is the traditional IRA, which offers short-term tax advantages as an incentive to build toward long-term saving.

The tax-deferred investment option offered by a traditional IRA is similar to the pretax contributions employees might make to a 401(k). But they also have a lower max contribution: $6,000 per year or $7,000 if you’re age 50 or older.

The drawback of contributions to a traditional IRA is that these funds need to be held in the account until you reach the retirement age of 59 ½ years of age (although there are a few exceptions). If you do withdraw any earnings, you will have to pay a penalty for early withdrawal on those earnings.

Greatest strength: You can save on taxes through retirement savings, especially if you’re currently in a higher tax bracket than you anticipate being in during retirement.

Roth IRA

Where the traditional IRA defers taxes on contributions until they’re withdrawn, the Roth IRA doesn’t offer any tax deferment. But the long-term payoff is significant. When you withdraw from this account in the future, all contributions and earnings can be withdrawn tax-free.

The contribution limits for a Roth IRA are the same as with a traditional IRA: $6,000 per year, or $7,000 for anyone aged 50 or older. While high earners may not be eligible to open a Roth IRA directly, there are options to move money into this type of account through what’s referred to as a backdoor Roth.

A Roth IRA also allows account holders to withdraw contributions at any point penalty-free, although earnings off of those contributions will be subject to both penalties and taxation.

Greatest strength: Roth IRAs allow you to save toward a retirement where you anticipate being in a higher tax bracket than your current situation. Roth IRA funds can also be a great asset in optimizing your tax planning in retirement.

SEP IRA

If you’re a self-employed individual, an SEP IRA provides an option for setting up an employment-based IRA as your own employer. It offers similar features and benefits as a 401(k), with some important distinctions.

The difference between an SEP IRA and most other retirement funds is the maximum contribution amount. Self-employed individuals can contribute either 25% of their employee compensation or a maximum amount of $58,000 for the 2021 tax year—whichever amount is lower. 

This large contribution amount lets self-employed workers make large contributions in years where business is going well to balance out years where contributions may not be as significant.

Greatest strength: An SEP IRA can supplement the lack of a 401(k) option for self-employed workers.

Other Types of IRAs

In addition to the aforementioned IRAs, you might also decide to open one of the less common IRA options:

• Self-directed IRA: This can be either a traditional or Roth IRA except you have more options when it comes to the assets in the account, such as real estate and commodities.
• SIMPLE IRA: This IRA offers an alternative to the 401(k) for small businesses and offers certain limitations (a lower contribution limit) and requirements to employers (a minimum matching contribution).
• Spousal IRA: In cases where only one spouse is regularly employed, a spouse can set up their own IRA with a contribution limit of $6,000 per year or $7,000 for those 50 and up.

IRA and 401(k)

Can you have an IRA and a 401(k)? Yes! While 401(k)s are a type of retirement account set up through your employer, it’s perfectly legal to set up and contribute to an IRA alongside a 401(k).

Each of these retirement accounts has its own contribution limits, but contributing to one doesn’t affect your contribution limit for the other. In addition, you may choose to set up multiple IRAs, such as a traditional IRA and a Roth IRA along with your 401(k).

In the end, your IRA choice should line up with both your current financial situation as well as your long-term financial goals and expectations regarding retirement income.

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