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The ABCs of IRAs

June 18, 2012

One misunderstanding that I run into quite a bit in my work is a lack of clarity regarding the various IRA options out there. There’s a lot of complex terminology, and there are plenty of plans that sound alike, but work very differently—so that confusion is understandable. It is important, however, to take the time to familiarize yourself with some of the basics, to ensure that you are able to make informed decisions about the kind of IRA that makes the most sense for your personal circumstances. One important distinction is the difference between SEP IRAs and SIMPLE IRAs. Let’s start with the terminology: SEP stands for Simplified Employee Pension plan, and SIMPLE stands for Savings Incentive Match Plan for Employees. The functional differences can have significant implications for your own financial planning. A SIMPLE IRA is set up by your employer, and is limited to companies that have 100 or fewer employees. Contributions to the account can be made by both the employee (who stipulates the amount they would like to contribute in regular deferrals) and the employer (who provides either a matching sum of either 3% of employee income or a non-elective contribution) up to a $28,000 annual limit. In contrast, a SEP IRA works more like a profit-sharing setup. The employer is actually the only one permitted to make contributions into employees’ IRA accounts, but there are potentially higher deposit limits. With a SEP, the annual maximum contribution is the lesser of $50,000 or 25% of an employee’s salary. An IRA account can only be funded up until the age of 70 ½ years. As one final note, please remember that if you are not employed and do not have any earned income, you can’t take an IRA tax deduction, and the contribution limits are much lower ($5,000-$6,000 annually depending on the age of the account-holder). Understanding the advantages and limitations of each account can be a significant asset in making the right decisions for your golden years.

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