3 IRA Accounts Explained: Roth vs Traditional vs SEP

in this video we'll cover the roth ira traditional ira and the step ira we'll go over the eligibility rules contribution limits income limits and withdrawal rules you'll have a much better understanding of these types of iras after this video alright the roth ira the roth ira was introduced as part of the taxpayer relief act of 1997 named after senator william roth it's a type of ira individual retirement account that allows you to contribute after-tax money for tax-free withdrawals under certain conditions when we say after tax we just mean that this money that's paid to you in your paycheck has already been taxed funds in your roth ira grow tax-free and then when you take qualified distributions you are not responsible for any additional taxes this is in contrast to a standard brokerage account in which investment earnings are taxed upon liquidation all right contribution limits you can only contribute up to six thousand dollars per year to roth ira for the year 2022 and if you're over 50 you can contribute another 1 000 for a total of 7k keep in mind this is the total of your roth and traditional ira contributions together and this is reviewed by the irs each year so it's always subject to change there are also income limits so not everyone can actually even contribute to the roth ira so to contribute to a roth ira in 2022 single tax filers must have a modified adjusted gross income of 144 000 or less up from 140 in 2021 if you're married in filing jointly your joint adjusted gross income must be under 214k if you're under these income limits you may want to consider the roth ira now as your first account before you become ineligible later on withdrawal rules your contributions are already taxed so you can withdraw these at any time without any taxes or penalties this is worth repeating you can withdraw your contributions to a roth ira anytime no matter what without any taxes or penalties it's only earnings that really matter here if you withdraw earnings and your account is over five years old those are also tax-free however if your account is less than five years old and you withdraw earnings you might be subject to taxes and penalties if you don't meet the requirements for a qualified distribution the earnings would be taxed according to your ordinary income rate as standard income and then you'd incur an additional penalty of ten percent here's an example if you have contributed twenty thousand dollars to roth ira over the years and now it's worth twenty five thousand dollars your account has twenty thousand dollars in contributions and five thousand dollars of earnings you can withdraw up to twenty thousand dollars at any time because you've already paid taxes on it however if your withdrawal exceeds that amount and then you dip into the five thousand dollars of earnings you might be subject to these taxes and penalties qualified withdrawals distributions eligible under irs regulations are referred to as qualified distributions while withdrawals that do not meet requirements are referred to as non-qualified distributions understanding the difference here is critical to avoiding significant tax liability first off if you're over 59 and a half you don't need to worry about this almost all withdrawals are tax and penalty free but if you're under 59 and a half you can still withdraw your earnings tax and penalty free if your withdrawal meets one of these situations you have a qualifying disability your estate or beneficiary is making the withdrawal after your death or you are purchasing your first home you can save up to 10k for this if your withdrawal is not qualified but one of the following situation supplies you would only owe taxes on the earnings but would avoid the 10 penalty you're using the funds to pay for college expenses for you or family members you're paying for medical expenses that exceed 7.5 percent of your adjusted gross income or you lost your job and use the funds to pay for your medical insurance premiums so what's the takeaway for the roth ira if you're under the income limit and assume that you'll continue to make a higher income going forward taking advantage of the roth ira could be super advantageous right now that way you take the tax hit now while you're in a lower tax bracket instead of later in your life when you're paying a higher tax break also don't underestimate the power of the roth ira for your home purchase not only can you withdraw the contributions tax and penalty free at any time but you can also use up to 10k in earnings for your first time home purchase this can be a super powerful tool to use as one of your main savings accounts for that down payment next one hit that subscribe button and turn on notifications that way you'll get notified every time we release new content alright traditional ira the traditional ira lets you save for retirement if you don't have a 401k through your employer and then gives you the tax benefits up front whereas the roth ira gives you the tax benefit upon withdrawal the traditional ira allows you to deduct your contributions from your income for tax purposes you then pay the taxes upon withdrawal the best way to think about this is this with the traditional ira you take the tax benefit up front by deducting your contributions from your income funds in your traditional ira then grow tax deferred instead of tax-free so when you withdraw the funds you owe taxes on the full map so this tax break is on the front end for those who want to save taxes on their income now as opposed to upon withdrawal contribution limits these limits are the same as the roth ira you can only contribute up to six thousand dollars per year to a traditional ira and then if you're over 50 you can contribute another one thousand dollars for a total of 7k you also can only contribute to the traditional ira if you're under 70 and a half these limits apply to the total of your roth and traditional ira contributions eligibility to receive the full benefit of this traditional ira you can only deduct your contributions from your adjusted gross income if neither you nor your spouse have access to a workplace retirement plan like a 401k if neither of you do you can deduct all of your contributions and there is no income limit if both you and your spouse have access to a 401k plan through work things get a little tricky to be eligible to fully deduct your contributions here your agi adjusted gross income must be less than 68k as a single filer or 109k as a joint filer if only one of you have access to a workplace retirement plan your adjusted gross income must be less than 204 000 there are also partial deduction limits that here as you can see withdrawal limits your contributions were not taxed yet so when you withdraw the funds they're treated as ordinary income and you owe taxes no matter what if you withdraw the funds after 59 and a half there's no additional penalty you just owe taxes on the withdrawal according to your ordinary income tax rate if you would draw the funds before 59 and a half you may owe the 10 penalty however like all iras there are exceptions to this rule called qualified distributions here are all the qualified withdrawals for the traditional ira meaning you would only owe ordinary income tax but avoid that 10 penalty you have qualified higher education expenses for yourself your spouse or children or grandchildren of yours or your spouse you are using a distribution of up to ten thousand dollars to buy build or rebuild the first home you have unreimbursed medical expenses that exceed 7.5 percent of your adjusted gross income you are in the military and are called to active duty for more than 179 days you have both become totally and permanently disabled you are the beneficiary of a deceased ira owner or in the year you become a parent through birth or adoption you can withdraw up to five thousand dollars from your ira thanks to the new secure act which went into effect in 2020 that's a lot of exceptions to the rule so what's the takeaway here with the traditional ira it might make sense for those who don't have any plans to withdraw funds before retirement and then think that they'll be in a lower tax bracket in retirement personally i'd rather assume i'm going to be in a higher tax bracket the longer i live and therefore i want to pay taxes now for me that's the roth ira it depends on the person though all right this set by array a simplified employee pension sep is an individual retirement account that an employer of a self-employed person can establish the employer is allowed a tax deduction for contributions made to a step ira and then makes contributions to each eligible employee's plan on a discretionary basis basically a sap ira is much like a traditional ira but instead it's for business owners and has a much higher cap eligibility sep iras are available for a variety of small business types including sole proprietorships partnerships limited liability companies llc's s-corps and c-corporations the plans can be an especially attractive option for a small business with a few or just one employee for instance and unlike some other retirement plans a set by array allows only the employer to contribute which in the case of a sole proprietorship is the employee as well can get confusing the employer contributes after-tax funds into the plan on behalf of the employee funds then grow tax deferred and whatever percentage of compensation employers set aside in the plan for themselves is the same percentage of pay that they must also contribute for each eligible employee to be eligible to participate in an employer separate employees must be at least 21 years old have worked at the business for at least three of the last five years and have earned at least 650 dollars from the job in 2022. set by arrays are used by small businesses and self-employed individuals to meet their retirement savings needs separates often have higher annual contribution limits than standard iras as well in a sense they're a cross between a traditional ira and then a 401k in the sense that like the latter they can receive employer contributions because the funding vehicle for a sep ira plan is a traditional ira sub contributions once deposited become traditional ira assets and are subject to many of the traditional ira rules including distribution rules investment rules contribution and deduction rules for traditional ira contributions basically the employee contribution which apply to the employees regular ira contributions not the sep employer contributions all right contribution limits contributions made by employers cannot exceed the lesser of 25 of an employee's compensation or 61 000 in 2022 when a business is a sole proprietorship that employee owner pays themselves wages and may also make a sap contribution which is limited to 25 of the wages or profits minus the sub contribution income limits the amount of compensation that you can use to calculate this 25 limit is limited to 290 000 in 2021 and 305 000 in 2022 you can still make over that amount as the employee but any income above that limit cannot be used in that 25 percent calculation can i have a sep ira and a roth ira you can actually combine a sap ira with a traditional or roth ira now if you're an employee who is covered by ira employer contributions don't reduce the amount that you can contribute to an ira for yourself but the amount of your traditional ira contribution that you can deduct may be reduced at certain higher income levels due to the combination of both plans withdrawal rules set contributions and earnings may be rolled over tax free to other iras and retirement plans as well as with a traditional ira withdrawals from set by arrays in retirement are taxed as ordinary income set contributions and earnings are held in sep iras and can be withdrawn at any time subject to the general limitations imposed on traditional iras a withdrawal is taxable in the year received if a participant makes it withdrawal before age 59 and a half generally a 10 additional tax applies qualified withdrawals there are a number of situations where the penalty may be weighed including the following death of the account holder disability certain higher education expenses a series of equal payments up to ten thousand dollars for first-time homebuyers as a result of irs tax levy's certain qualified unreimbursed medical expenses health insurance premiums while unemployed qualifying situations in which a military reserve is called for active duty if any of these exceptions apply distributions taken before the age of 59 and a half are still subject to income tax but account holders are not responsible for the additional 10 penalty that's a lot of information on iras roth traditional incept i hope that helps gives you a nice little breakdown of which one you want to choose either way start building your wealth through one of these investment accounts i'm tony from wealthfront take care you

Channel: Wealthfront

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Keywords: 3 types of ira accounts, 3 Types of Investment Accounts You Should Know, Roth vs traditional vs sep ira, retirement plans for beginners, self employed retirement plan, difference between traditional and roth ira, why should i invest in a roth ira, limitations roth ira, roth ira contribution limit, best investments to minimize taxes, how investing can save you money on taxes, how to avoid taxes on investments, Difference between 401k and ira, wealthfront, tax loss harvesting

Id: ESQ-PUrB-04

Length: 12min 10sec (730 seconds)

Published: Thu Apr 07 2022