Savings and Retirement: What types of non-employer-sponsored accounts are available?
Workers can receive tax-favored benefits for retirement saving through arrangements that do not involve their employer. The Individual Retirement Account (IRA) comes in two forms, traditional IRAs and Roth IRAs. (Other types of IRAs are available to workers through their employer, including SIMPLE and SEP plans.) The primary difference between traditional and Roth IRAs is in the timing of the tax on contributions. Qualified contributions to traditional IRAs are excluded from tax and allowed to grow tax-free, but withdrawals during retirement are taxed. Contributions to Roth IRAs, conversely, are taxed in the year they are made but are allowed to grow tax-free, and withdrawals during retirement are not taxed. About 45 million households own at least one IRA.
- Traditional IRAs and Roth IRAs also differ in the amount of funds that can be sheltered from taxation, with Roth IRAs shielding a higher level of funds from taxation than traditional IRAs. This is due to the Roth IRA characteristic that allows contributions to grow tax-free and never be taxed after the initial contribution, which is generally more favorable than the tax treatment of contributions with a traditional account.
- The tax code limits the extent to which individuals may take advantage of the tax benefits associated with traditional and Roth IRAs. Taxpayers with income beyond a certain level, which varies with filing status, may not contribute to a Roth IRA and may not deduct contributions to a traditional IRA; taxpayers who participate, or whose spouse participates, in an employer-provided pension also may not deduct traditional IRA contributions if their income exceeds a certain amount.
- Since traditional IRAs were originally designed to be a parallel tax benefit for employees lacking access to an employer-sponsored saving plan such as a 401(k), taxpayers participating in such a plan face stricter criteria for traditional IRA eligibility.
- For single taxpayers without access to an employer-sponsored pension, and for married couples where neither spouse participates in such a pension, there are no income restrictions on the deductibility of traditional IRA contributions. A married taxpayer who does not participate in an employer-sponsored plan but whose a spouse does participate may contribute the maximum statutory amount to an IRA, provided the couple’s joint income does not exceed $156,000.