What types of nonemployer-sponsored retirement savings accounts are available?
The two big types are traditional individual retirement accounts (IRAs) and Roth IRAs. The main difference: when the feds take their cut.
Traditional IRAs versus Roth IRAs
Workers and their spouses do not need their employers’ help to save in tax-favored retirement accounts. Individual retirement accounts mostly come in two forms: traditional IRAs and Roth IRAs. (Other types of IRAs, such as IRA-SEPs and SIMPLE-IRAs, are only available through employers.) The primary difference 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 are taxed. Contributions to Roth IRAs, conversely, are taxed in the year they are made. But account assets are allowed to grow tax-free, and withdrawals during retirement years are not taxed. Even though the statutory contribution limits are the same for both types of accounts, the effective amount that a saver can place in tax-preferred status is higher with a Roth IRA because the contribution is made with post-tax income.
As of 2015, 40.2 million households (or 32 percent) owned at least one IRA. Some 30.4 million households (or 24.4 percent) held traditional IRAs, while 20.3 million owned a Roth IRA. Some households owned both.
The Fine Print
These rules are a bit confusing. Taxpayers with income greater than a specified level, which varies with tax filing status, may not contribute to a Roth IRA and may not deduct contributions to a traditional IRA. Nor may taxpayers who participate (or whose spouses participate) in employer-provided pensions deduct traditional IRA contributions if their income exceeds a specified limit.
For single taxpayers without access to an employer-sponsored pension, and for married couples in which neither spouse participates in such a pension plan, 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 spouse does, may contribute the maximum statutory amount to an IRA, provided the couple’s joint income does not exceed $186,000.
Burman, Leonard, William Gale, and David Weiner. 2001. “The Taxation of Retirement Saving: Choosing Between Front and Back-Loaded Options.” Washington, DC: Brookings Institution.
Congressional Budget Office. 2011. Use of Tax Incentives for Retirement and Saving in 2006. Washington, DC: Congressional Budget Office.
Holden, Sarah, and Daniel Schrass. 2016. “The Role of IRAs in U.S. Households’ Saving for Retirement, 2015.” Washington, DC: Investment Company Institute.