- Traditional IRA
- Roth IRA
- SEP IRA
- SIMPLE IRA
Distributions are also governed by rules and exceptions to those rules. Distributions are subject to your current income tax rate and are also subject to a 10% penalty if withdrawn before reaching the age of 59 1/2.
A 401(k) account can also be rolled over into a traditional IRA because the tax treatment is the same (tax deducted at the time of contribution and paid at the time of distribution).
2. Roth IRA: A Roth IRA is a similar vehicle to a traditional IRA with the same combined contribution limit of $5,000, as noted above, or $6,000 if you are 50 years of age or older. Contributions are also subject to the same AGI limitations. The primary difference is the tax treatment as contributions are not tax deductible. The tax advantage, though, is that the distributions received from a Roth IRA, as well as any gains those contributions earn, are not taxable. The taxes are paid in the year of the contribution (because it is not tax deductible) rather than in the year of the distribution, as is the case with a traditional IRA. Even though you miss out on the tax deduction, you may pay less tax on the contribution than you would on the distribution if you are in a higher tax bracket at the time of the distribution. I personally like the tax advantages of a Roth IRA and knowing that the earnings growth and distributions are tax-free.
Distributions are also subject to a penalty of 10% if taken before reaching age 59 1/2 or if withdrawn within five years of opening the Roth IRA.
3. SEP IRA: A Simplified Employee Pension (SEP) IRA is an employer established and funded SIMPLE IRA and is often used by small business employers in place of a 401(k). Employers can contribute directly to employees’ traditional IRA accounts, or sole proprietors can contribute for their own benefit. The tax advantages and early distribution penalties are the same as a traditional IRA.
4. SIMPLE IRA: Savings Incentive Match Plan for Employees (SIMPLE) IRAs are retirement plans sponsored and administered by employers, which allow employers to contribute up to $11,500 (limit for 2010). These can also be used for sole proprietor's benefit. The tax advantages and early distribution penalties are the same as a traditional IRA. The penalty becomes 25% if the distribution is within two years of first participating in the SIMPLE IRA plan.
As noted, these are the basics for understanding IRAs as an investment vehicle for retirement. The IRS regulations regarding IRAs are considerably more extensive but mostly apply to special circumstances and exceptions to the general rules. These basics can assist in finding the right retirement account for you.