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The Four Types of IRAs

Barbara Marquand | guest writer for GoTalkMoney

Individual retirement accounts were created in 1974 as way for people to make investments for their golden years when their companies didn't offer them pensions. Today they're a staple in retirement planning.

IRAs come in several varieties. With a traditional or Roth IRA, you can set up a retirement savings account with a bank, stock broker, or mutual fund, and have your contributions invested in money market accounts, CDs, stocks, and mutual funds. Here's a look at those two types of plans as well as two types of employer-sponsored IRAs:

Traditional IRA

Contributions to a traditional IRA may be deductible from your income taxes, depending on your income tax filing status, and your account grows tax free until you make withdrawals. Then you pay income taxes on money you take out, and there are minimum distribution requirements starting at age 70 1/2. You'll get hit with a 10% federal tax penalty plus income tax on the withdrawal amount if you take money out before age 59 1/2. You can contribute up to $5,000 to a traditional IRA this year and an additional $1,000 if you're 50 or older

Roth IRA

The Roth IRA, created in 1997, was off-limits to high-earners until this year, and it continues to offer appealing advantages to younger investors. Contributions to Roth IRAs are made with after-tax money, and distributions are tax-free--a key difference from the traditional IRA. In addition, the Roth allows some tax-free withdrawals before retirement, including up to $10,000 for a first home after the account has been established for at least five years and money for children's college educations. There is no minimum distribution level for Roth IRAs after age 70 1/2--another difference from traditional IRAs, so you take out only the money you need when you're retired. This year you can contribute up to $5,000 to a Roth IRA and an additional $1,000 if you're 50 or older.

SEP IRAs

A SEP--or Simplified Employee Pension--is an IRA set up by an employer for its employees. It's called a simplified plan because it's easy for the employer to set up, and the administrative costs are lower than they would be for a more complex plan. The big difference between a SEP and SIMPLE IRA is that only the employer contributes to the SEP. The contribution obligations are flexible, and a company of any size--even a sole proprietor--can set up a SEP IRA for its employees. If you're self-employed, talk to your financial adviser about whether you should consider setting up a SEP IRA for yourself. This year employers are limited to contributing up to 25% of an employee's compensation or $49,000, whichever is less.

SIMPLE IRAs

A small employer can set up a Savings Incentive Match Plan for Employees IRA. Employers can match employees' contributions dollar for dollar up to 3% of pay or 2% of pay for an employee who elects not to contribute to the plan. An employer has to contribute to a SIMPLE plan, and an employee may contribute. As an employee, you can contribute up to $11,500 in 2010 to a SIMPLE IRA, and if you're 50 or over, you can add another $2,500. You'll face a 10% federal tax penalty if you withdraw money before age 59 1/2, and a 25% penalty if you withdraw anything in the first two years of participation.

With Americans falling short on retirement savings, boosting your contributions to an IRA, no matter which kind you have, is a good idea if you're not already contributing up to the limits.

Disclaimer:This content is not provided or commissioned by American Express. Opinions expressed here are author's alone, not those of American Express, and have not been reviewed, approved or otherwise endorsed by American Express. This site may be compensated through American Express Affiliate Program.

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