The 4 Types of IRAs: How to Pick the Right IRA For You

February 15, 2022
Learn about the four types of IRAs (Roth, Traditional, Rollover, and SEP) and how to choose the best one for your retirement savings.
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Britt & Laurie Anne
Two female investors in their 30s with a collective net wealth of over $6 million+
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You’ve probably heard of Roth IRA or traditional IRA, but have you heard about the other two types of IRAs?

Here’s everything you need to know about the four types of IRAs and how to choose the best one for you.

What is an IRA?

IRAs exist to help you save money for retirement while saving money on taxes.
To put it simply, you put money in, invest it, and you take the money out when you’re ready to retire. Each type of IRA offers you a different type of tax exemption or tax benefit. In some cases, there are penalties if you withdraw your money before age 59 ½ so you have to pay attention to the rules.

There are several different types of IRAs, each with different advantages and limitations. Depending on your retirement goal and journey, one might be better for you than the other.

Now before I go into the details of the four types of IRAs, I want to reiterate the importance of starting to save for retirement early. Don’t get stuck in analysis paralysis. Just pick one and start saving, because the sooner you get started, the more time your money has to grow and the more money you will have in retirement.

What’s a Roth IRA?

The Roth IRA is the most flexible type of IRA account. With a Roth IRA, you pay taxes on the money before you put it in this type of account. Because of that, you’re allowed to withdraw the money you’ve contributed without penalty.

However, just because you can take it out, doesn’t mean you should. Ideally you would keep it invested so you can benefit from compound interest over the long-term.

Each year, you are allowed to invest a certain amount into your Roth IRA. In 2022, the Roth IRA contribution limit is $6,000 if you’re under 50 and $7,000 if you’re over 50. There are limits from the government as well. If you make more than a certain amount of money, you’re not allowed to invest in a Roth. In 2022, your adjusted gross income can’t be more than $144,000 if you’re single and $214,000 if you’re married and filing jointly, according to the most recent announcement from the IRS.

Ideally, you want to contribute as much as you can to your Roth IRA before you start earning so much money that you aren’t eligible anymore.

Here’s the best part about a Roth IRA: after you make your contributions and invest them, then you just let the money sit there and compound over the years. When you turn 59 ½, you can take all of the money out, including all of the growth, and not have to pay a single dollar of taxes on it. And that is why we love Roth IRAs.

So take advantage of them! If you make less than $144k as a single person or $214k as a married person, definitely contribute the maximum amount to your Roth IRA and invest it aggressively.

types of IRAs - Roth IRA

One important thing to note: you can take the money you’ve contributed to a Roth IRA out at any time without penalty, which makes it kind of like a savings account.

But pay close attention, because you can only take out what you’ve contributed without paying a fee. If you try to take out all of it -- what you contributed and the gains you’ve made on your contributions -- before age 59 ½, then you’ll have to pay a fee unless you qualify for a government-approved exemption, such as a first-time home purchase, educational expenses, paying for a birth or an adoption, if you become disabled or pass away, or if you need to pay for a medical expense or health insurance if you’re unemployed.

What’s a Traditional IRA?

Unlike a Roth, with a traditional IRA, you contribute pre-tax money, which means you don’t pay taxes on the amount you’re putting in; instead, you have to pay taxes when you withdraw the money. The amount will depend on your tax rate in the year you take out the money.

The benefit of contributing to a traditional IRA is that you can get a tax deduction for your contribution. For example, if your income was $150,000 and you contribute $6,000 to your traditional IRA, your adjusted gross income is now $144,000. Although if you have access to a retirement plan at work, you may not be able to deduct all your IRA contributions on your taxes.

Unlike a Roth IRA, there are no income limits for a traditional IRA, meaning it doesn’t matter how much money you make.

But like a Roth, there is a limit as to how much you can deposit into your traditional IRA each year, which is the same amount as the Roth IRA: $6,000 if you’re under 50 or $7,000 if you’re older than 50.

Keep in mind that if you plan to contribute to both a Roth and a traditional IRA in the same year, your combined contributions cannot exceed the limit. So you can’t contribute $6k to your Roth AND $6K to your Traditional, you’d have to do $3 and $3 or more if you’re over 50.

Same as a Roth, you can take your money out of a traditional IRA after you turn 59 ½. If you take it out sooner than that, you will have to pay a 10% penalty fee and the amount you take out will be added to your gross income and you’ll have to pay income tax on it.

The government does have exceptions in place (like a Roth) if you really need to take the money out before you hit retirement age. But make sure you talk to a financial advisor and/or an accountant before you do that because it might not make the most financial sense.

types of IRAs - traditional IRA

Okay, now onto the two types of IRAs you might not have heard of before, but are really important to know about!

What’s a Rollover IRA?

Opening a rollover IRA allows you to move funds from an old retirement account into a new account without paying taxes or early withdrawal penalties.

The most likely scenario for using a rollover IRA account is if you had an employer-sponsored 401(k) and you don’t work for that employer anymore. In that case, assuming you were paying high fees to invest your 401(k), which is common, you would want to open a Rollover IRA and transfer (or “roll over”) the funds.

Again, the benefit of doing this is to preserve the investment account and not pay taxes or early withdrawal penalties for moving it around.

If you are planning to do this, make sure you talk to your brokerage firm about the specific steps involved. You want to make sure you follow the rules to a tee to avoid getting stuck paying any fees.

types of IRAs - rollover IRA

What’s a SEP IRA?

A SEP IRA stands for Simplified Employee Pension. It’s a great retirement account for self-employed or small-business owners. Just like a traditional, contributions are tax-deductible now but are taxed at withdrawal.

A SEP IRA is great because the contribution limits are 10x that of a traditional or a Roth. In 2021, you can contribute up to $58,000, which could have a significant impact on your tax bill.

types of IRAs - SEP IRA

FAQs about IRAs

Now that you know the different types of IRAs, let’s tackle some frequently asked questions about IRAs:

Should you open up an IRA if you already have a 401(k)?

The short answer is yes. It’s very common to have both types of IRAs, especially if you’re trying to maximize your retirement savings or minimize your tax burden.

If you have access to an employer-sponsored retirement account like a 401(k), see if your employer matches your contributions and make sure you deposit enough to get that match—it’s free money.

Afterwards, it makes sense to move the rest of your contributions to your IRA and max that out. Then you can go back to your 401(k) and max that beyond the match. In 2022, you are allowed to contribute $20,500 a year to your 401(k) if you’re under 50 and an additional $6,500 if you’re over 50.

We recommend doing this back and forth shuffle because you have more flexibility and usually lower costs with your IRA than your 401(k).

So you want to take advantage of the free money with the matching. Then max out your IRA, then go back to the 401k and max it out with your remaining retirement savings.

How do I open an IRA?

It’s super easy! You can do it in less than 10 minutes online.

Just go to your favorite brokerage (like Vanguard, Fidelity, or Schwab) and click the links to open up an IRA. You’ll want to know ahead of time what type of IRA you’re opening – a Roth, Traditional, Rollover, or SEP. (Need help picking a brokerage? Check this out.)

After you open the account, you will need to transfer money into it from another account and choose your investments. One easy way to get started is by investing in Index Funds, which easily diversify your portfolio and can set you up for high growth with little management.

After I open my account…what’s next?

Make sure you actually invest your money. Once you contribute to an IRA, it’s easy to think your money is working, but most often, it’s just sitting in the account. I hear about this all the time!

If you get stuck, call your brokerage and make sure your money is invested. You want to make sure it’s benefiting from compound interest from day one!

I hope this helped you figure out the different types of IRAs so you can pick a retirement plan and enjoy your golden years. If you want to learn more about growing your money and making sure you’re prepared for retirement in other ways, check out our free masterclass, Think Like an Investor.

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