Saving up cash under your mattress is one way to set aside funds for the future, but there are much better ways to save for retirement. An individual retirement account (IRA) is a flexible way to save for retirement with potential tax advantages. You can lower your taxable income now with traditional IRA contributions or lower taxes on withdrawals in retirement with a Roth IRA. However, an IRA isn’t necessarily the best option in all situations. Read on to learn about the pros and cons of IRAs.
What Are the Types of IRAs?
There are two fundamental types of IRAs: traditional and Roth IRAs. Other plans offer different ways for employers to provide IRAs, so you may have additional options depending on what your employer offers.
- Traditional IRA: These are funded with pre-tax contributions (if you meet income limits) but you pay taxes when withdrawing funds. The contribution limit is $7,000 per year for 2024 ($8,000 if you’re over 50). Traditional IRAs require minimum distributions (RMDs) starting at age 73. Anyone earning money can get a traditional IRA, though income limits apply in some situations.
- Roth IRA: You fund a Roth IRA with after-tax contributions but don’t pay taxes on withdrawals as long as they are qualified distributions. To qualify, you’ll need to have owned the Roth IRA for at least five years and be 59 ½ years of age or older. The same contribution limits as a traditional IRA apply. You must set up your own Roth IRA—Employers don’t offer them.
- SEP IRA: This is a traditional IRA held within a simplified employee pension (SEP) plan. Only an employer contributes to a SEP IRA and they contribute the same amount to each employee plan during a given year. Employees can choose how to invest their funds in the IRA. The employer is limited to contributing 25% of the employee’s compensation or $69,000 in 2024, whichever is less. Self-employed people can also have this type of IRA.
- Simple IRA: This is a traditional IRA geared toward small businesses that don’t have another retirement plan set up. Employers are required to match 1% to 3% of the employee’s salary reduction contribution or a flat 2% whether the employee contributes or not. Employees can contribute up to $16,000 in 2024. Self-employed people can also start this type of IRA.
- Payroll Deduction IRA: This simple plan allows employees to contribute to a Roth or traditional IRA through a payroll deduction. The employer doesn’t have to match contributions or file any documentation. The employee first sets up a traditional or Roth IRA and then authorizes their employer to deposit part of their pay directly into the account. The direct deposit function is the only difference between a payroll deduction IRA and an independent traditional or Roth IRA.
Advantages of IRAs
IRAs offer a wide range of benefits for retirement investing, from tax advantages to estate planning (depending on the account).
| Benefit | Description |
| Tax advantages | Traditional and Roth IRAs give your money a boost compared to investing in the market directly. Traditional IRAs reduce your taxable income while you contribute and the pre-tax money can compound with interest. Roth IRAs provide tax-free growth and lower taxes for withdrawals. |
| Multiple investment options | As an IRA owner, you have many options for how you want the money to be invested in stocks, bonds, bank CDs, and mutual funds. IRAs have more investment options than 401(k) plans. |
| Transferability | If you change jobs, you can roll over an employer-sponsored SEP or Simple IRA into a new account within 60 days. This lets you keep the tax-advantaged status of the funds and avoid early withdrawal penalties. |
| Estate planning (Roth IRA) | A Roth IRA doesn’t have required minimum distributions, so you can keep money invested throughout your lifetime. You can name beneficiaries and gift the IRA to your kids. |
| Employee matching (Simple IRA) | If you work for a small business with a Simple IRA, your employer can match up to 3% of your compensation in contributions. |
Note: Any reference to the taxation of IRAs in this material is based on Annuity.com’s understanding of current tax laws. We do not provide tax or legal advice. Please consult a qualified tax professional regarding your personal situation.
Disadvantages of an IRA
While IRAs present great opportunities to invest for retirement, they do come with some drawbacks.
| Drawback | Description |
| Maximum contributions | Roth and traditional IRAs have contribution limits of $7,000 per year ($8,000 if you’re over 50). This single limit applies across all traditional and Roth IRAs you may have. |
| Early withdrawal penalties | You’ll pay a 10% federal tax to withdraw money before age 59 ½. This 10% tax also applies if you withdraw from a Roth IRA you started less than five years ago, no matter your age. |
| Required minimum distributions (RMDs) | A traditional IRA requires minimum distributions once you turn 73 years old (or 75 if you were born after 1960). The distribution is based on your account balance divided by your life expectancy. This applies to all employer-sponsored IRA accounts but not Roth IRAs. |
| Roth IRA income restrictions | You can make too much money to contribute to a Roth IRA. Single people making between $146,000 and $161,000 per year can contribute a reduced amount, while someone making more than $161,000 can’t contribute to a Roth IRA that year. A married couple has lower contribution limits when making over $230,000 and can’t contribute when making over $240,000. |
| Traditional IRA income restrictions | If you have another employer-sponsored retirement plan, you can deduct the full contribution to your IRA if you make under $77,000 per year, partial if you make up to $87,000, and none if you make over $87,000. Limits are higher for married couples with an employer retirement plan. Single earners and married couples without an employer retirement plan can deduct the maximum amount per year no matter their income. |
| Employers don’t match some plans | While a Simple IRA offers employer matching, traditional and Roth IRAs don’t have an employer match option. |
Who Is an IRA Right For?
If you want to save for your retirement, an IRA can be a great option. An IRA is more flexible than a 401(k) because you can start a traditional or Roth IRA on your own. An IRA is also an easy way to take advantage of tax-advantaged investments.
That said, only small businesses with Simple IRA plans can match your contributions. If your employer offers a 401(k) plan with a match, it’s a good idea to use this option first to maximize your retirement savings. You might consider contributing to an IRA after that point if you want more flexible investment choices or to use a Roth account.
Also, take some time to think about what you’d pay in taxes during retirement to choose an IRA. With a traditional IRA, you pay taxes on 100% of withdrawals during retirement. Withdrawals increase your taxable income in retirement and can bump you into a higher tax bracket. In contrast, Roth IRA withdrawals aren’t taxed as long as the account is at least five years old and you’re 59 ½ or older. If you anticipate being in a high tax bracket during retirement, having a Roth IRA can help keep you from moving even higher.
Lastly, self-employed people can have SEP IRAs or Simple IRAs. A SEP IRA, in particular, lets you contribute a maximum of $69,000 per year, which is a huge sum to invest.
IRA Alternatives To Consider
There are many other ways to save for retirement. You might find a 401(k) or HSA presents a better option for your situation, for example.
- 401(k) plans: Many employers offer 401(k) plans, which allow you to contribute up to $23,000 per year as of 2024. This lowers your taxable income for now, though you’ll pay income tax on withdrawals during retirement. Employers often match 401(k) plans to a limited degree. You can also choose a Roth 401(k) if your employer offers it.
- Taxable brokerage account: With a brokerage account, you can invest in almost anything and buy and sell securities on a whim. These accounts may have higher earning potential, but are also subject to market changes and can lose some or all of their value. You’ll pay taxes on gains and dividends each year, though.
- Health savings account (HSA): If you have a high-deductible health plan, you can get an HSA to save up to $4,150 per year for individuals and $8,300 for families of pre-tax dollars for health costs. Contributions grow tax-free and disbursements aren’t taxed as long as they’re for qualified medical expenses. Once you turn 65, you can withdraw funds for any reason and pay normal income tax on withdrawals that aren’t for qualified medical expenses.
- Annuities: Annuities can provide benefits in retirement like guaranteed retirement income in exchange for premiums paid to an insurance company. Deferred annuities grow over time, and options like fixed and fixed-indexed annuities can provide principal protection (subject to a surrender charge and/or a market value adjustment).
Note: All annuity guarantees are subject to the claims-paying ability of the insurer.
IRAs and Annuities Can Work Together
There’s a lot to consider when planning for income sources in retirement. But the choice between IRAs and Annuities doesn’t have to be binary. On the one hand, you can choose to split your savings between traditional or Roth IRAs and nonqualified deferred annuities. However, you can also use a variety of retirement plans to fund annuities directly. In this way, you can establish traditional IRA 401(k) or 403(b) qualified annuities, or Roth IRA nonqualified annuities.
Different IRA and annuity strategies may provide different income levels and benefits for your retirement. To learn more about your annuity options and see how they can complement other retirement savings plans, reach out to a licensed annuity agent today.
