How Retirement Accounts Work
May 20, 2022
The road to retirement is paved with savings.
An individual retirement account — an IRA — is an essential tool to fuel your savings strategy.
An IRA won’t just help you protect and grow your money. It will also aid you in capitalizing on tax breaks every year.
While IRAs might sound complex, they can be easily opened and funded in a matter of minutes.
During periods of peak inflation, a retirement account truly belongs in your financial arsenal.
Here’s a quick rundown of IRAs:
Retirement Accounts: Explained
What is an IRA?
It is simply a tax-deferred investment account.
In other words, you’ll never have to worry about getting taxed on trades in an IRA — so long as you leave the money in your account. Thanks to the power of compound interest, your savings will continue to grow over time.
The longer you wait to withdraw, the better.
When it comes to IRAs, there are three primary rules to consider:
- IRAs have annual contribution limits of $6,000, or $7,000 if you’re age 50 or older.
(Note: these are fixed figures across all of your retirement accounts.)
- You must earn an income to open an IRA (unless you and your spouse are filing jointly)
- If you withdraw your money before age 59 1/2, you’ll face a 10% penalty and a tax bill (unless you qualify for an IRS exception)
There are multiple IRAs to choose from, depending on your unique financial situation.
The Four Types of Retirement Accounts
IRAs aren’t useful for saving money alone. They’re also able to lessen your annual tax burden.
After all, if you decide to contribute $6,000 to an IRA, you’ll lower your taxable income by the same amount.
So while you’ll be “paying yourself first,” you’ll also be paying less to the IRS.
It’s a win-win.
The question is, which type of IRA should you open? There are four primary options of which you can mix and match.
After all, while there’s a cap on your total contributions, there’s no limit to the number of retirement accounts you can open.
The Traditional IRA
Contributions to a traditional IRA are considered “tax-deductible.” In other words, the amount you contribute to your retirement account directly reduces your taxable income.
For example, if you make $60,000 a year and put $6,000 from your earnings into a traditional IRA, your taxable income would then be $54,000.
While the contributions are tax-deductible, your withdrawals will be taxed as ordinary income.
The Roth IRA
Unlike a traditional IRA, contributions to a Roth IRA are not tax-deductible.
However, because you will have already paid tax on your contributions, your withdrawals will be 100% tax-free.
The question then becomes, “would you rather pay taxes now, or pay them later?”
Given the fact that tax rates perpetually increase, it might make more sense to pay your taxes today — especially if your peak earning years are ahead of you.
The SEP IRA
If you’re self-employed or a small-business owner, SEP IRAs present a compelling option.
As with a traditional retirement account, SEP IRAs contributions are tax-deductible and grow tax-deferred until withdrawal.
For tax year 2021, you have two ways to contribute:
- Either 25% of your total compensation, or
- Up to $58,000
Note: To be eligible to participate in your employer’s SEP IRA, you must be at least 21 years old and have been employed in the company for three of the last five years.
The SIMPLE IRA
SIMPLE IRAs stand for “Savings Incentive Match Plan for Employees” individual retirement accounts.
Unlike SEP IRAs, SIMPLE IRAs are for small businesses with fewer than 100 employees.
As with traditional IRAs, contributions are tax-deductible, and investments grow tax-deferred until withdrawal.
For tax year 2021, employees under the age of 50 can contribute up to $13,500.
Note: Those older than 50 can make catch-up contributions of up to $3,000.
Where (& how) to open an account
Opening an IRA is easy.
You can do so through any broker, robo-advisor, or financial institution — whether in-person or online.
To open your account, you’ll need to provide basic information like your full name, address, and Social Security Number (SSN).
Once you select your provider (and the type of IRA you’d like to open), you’ll be asked to transfer funds from a savings or checking account.
Or, if you would rather fund your new IRA through a 401(k) rollover, you’ll need to provide the following information:
- Your employer’s name
- Your employer’s address
- Your current 401(k) manager
Note: Your 401(k) rollover will not count towards your annual IRA contribution limits, as that money has already been invested.
Investing in an IRA is a powerful step towards establishing your financial future.
While keeping your eyes fixed on the long-term horizon, you deserve to get rewarded today.
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*Flyp is not a bank. Banking services provided by Sutton Bank, Member FDIC. Rewards provided by Flyp. READ THE FLYP REWARDS OFFICIAL TERMS BEFORE PARTICIPATING. NO ACCOUNT OPENING OR PAYMENT IS NECESSARY TO ENTER OR WIN. SEE THE RULES FOR WAYS TO ENTER.
“Flyp does not provide tax advice. This material has been prepared for informational purposes only, it is not intended to provide, and should not be relied on for tax advice. You should consult your tax advisors before engaging in any transaction.”
Mucha, Sarah. “Inflation is hitting battleground states worse.” Axios. Axios, March 14, 2022. https://www.axios.com/inflation-is-hitting-battleground-states-worse-71f3ecec-37fc-48a3-9432-55f82ac94471.html
Internal Revenue Service. “Retirement Topics – IRA Contribution Limits.” IRS.
Fox, Michelle. “Even if you aren’t working, you may be able to open an IRA. Here’s how.” CNBC. CNBC, August 16, 2021. https://www.cnbc.com/2021/08/16/how-to-open-an-ira-even-if-you-arent-working.html#:~:text=While%20you%20typically%20need%20to,both%20partners%20can%20make%20contributions
Internal Revenue Service, “Retirement Topics – Exceptions to Tax on Early Distributions.” IRS.
Internal Revenue Service, “SEP Plan FAQs.” IRS. https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-seps
Stewart, Jackie. “SEP IRA Contribution Limits for 2022.” Kiplinger. Kiplinger, December 17, 2021. https://www.kiplinger.com/retirement/retirement-plans/603955/sep-ira-contribution-limits-for-2022