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What Is an IRA, and What Options Do You Have?

Are you considering an IRA (Individual Retirement Account) for your small business retirement plan? It’s likely you are focused on running your business, tracking income and expenses with your online accounting for small business, and have little time to think about the future. So here’s a quick overview to help you.

The first step is answering the question, “What is an IRA?”

What is an IRA?

By definition, an IRA is a type of investment used for storing funds for retirement. It often has certain tax advantages over traditional savings strategies (e.g., savings account, certificate of deposit (CD)). The tax breaks make an individual retirement account well suited for the purpose of storing retirement money, often using stocks, bonds, and mutual funds to hold the funds.

You or your accountant can take a look at your financials to determine what funds may be available to invest for retirement.

Why create a retirement fund?

Many individuals are unable to live on their Social Security benefits and other income after retirement. Experts say we tend to spend 85% of what we spent when we were working, which is often more than our retirement income. Even folks with employer-sponsored 401(k) savings plans are simply no longer able to make up for the “funds beyond Social Security” that they need during retirement.

This is why more and more people are looking at retirement plans and seeing the advantage of contributing to an individual retirement account. Aside from supplementing an existing retirement plan, an individual retirement account also provides a number of different tax breaks. And as an employer, individual retirement accounts can be less expensive than 401(k) plans.

As a small business owner, you can think about IRAs for yourself — and for your employees. Here are the bare bones facts about the most common individual retirement accounts.

Your IRA Options

Once you’ve answered the question, “What is an IRA?” you will need to consider your options. There are several kinds of individual retirement accounts, and most of the accounts have maximum annual contributions. The most popular are the Traditional IRA, the Roth IRA, the SEP IRA, and the SIMPLE IRA.

Traditional IRA

A traditional individual retirement account is basically a savings account where all tax payments are deferred. The account holder will only have to pay taxes when they start withdrawing money during their retirement. Theoretically, you end up paying less tax on that deferred income because your tax rate during retirement is likely to be lower than it was when you were working.

While you are accumulating investments in your individual retirement account, none of these investments are subject to taxes. That means interest payments, dividends from shares of stocks, capital gains, and other income from investments can grow faster since there are no tax deductions.

Roth IRA

With a Roth IRA, taxes are usually paid before the money is added to the account. Taxes are not collected when a withdrawal is made. That means that with a Roth IRA, you can grow your money without the need to pay taxes on the accumulating interest. Upon reaching retirement age, you can withdraw any or all of the money.

Unlike a traditional IRA, your funds are not taxed when withdrawn.

SEP IRA

A Simplified Employee Pension IRA or SEP IRA is very similar to a traditional individual retirement account, but it is specifically for self-employed individuals or small business owners. A major advantage of a SEP IRA account over a traditional IRA is that the SEP does not have a maximum contribution limit.

The Department of Labor (DOL) and the IRS both offer detailed information on this type of IRA.

SIMPLE IRA

A Savings Incentive Match for Employees or SIMPLE IRA is basically the same as a SEP IRA. What makes it different, however, is that a SIMPLE IRA allows employees to make contributions to the account. It also makes contributions by employers a requirement, unlike some other IRA options.

Who can open an IRA account?

You’ve answered the question, “What is an IRA?” and you are aware of the options; but which options are you eligible for? Not everyone is eligible to have an individual retirement account. Generally speaking, an individual retirement account is a voluntary type of an account, and an individual can open one through a financial institution (e.g., brokerage firm, bank, mutual fund company).

Every kind of IRA account has its own set of rules and qualifications that a person must meet before they can open an individual retirement account of that type. Most restrictions are based on the amount of income or the status of employment. For the most up-to-date information about contribution ceilings, etc., check the IRS website.

You will want to consult your tax professional or financial planner before making any decisions about an IRA. Crunch the numbers and see if an IRA is right for you and your business.

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