How old are you? Do you know your contribution and deferral capabilities? Are you a sole proprietor or a business owner, with or without common law employees? When you wish to retire? What is your current tax situation? Do you seek to make the highest contribution and have the most flexibility?
These are important questions to ask yourself when considering which type of retirement account can meet your needs and help satisfy your goals. You can review the specific nuances between self-directed IRAs here, but let's examine the general differences here.
A Traditional IRA is an individual retirement account. Any person earning taxable compensation through employment income or self-employment income is eligible to open a Traditional IRA. A Traditional IRA is a "pre-tax" account. All contributions are tax-deductible for the year the contribution is made. Funds in a Traditional IRA can grow tax-deferred until the account holder makes a distribution. At age 59 ½, the account holder may take distributions without penalties, though withdrawn balances would be taxed at the account holder’s ordinary income rate.
A Roth IRA is also an individual retirement account. As with Traditional IRAs, account holders must earn taxable compensation and meet certain requirements concerning their modified adjusted gross income. Those whose income is above a certain amount may be ineligible to make Roth IRA contributions. A Roth IRA is a “post-tax” account, meaning contributions are taxed as regular income in the year the contribution is made. Earnings generated by investments are tax-deferred, and qualified distributions can be tax-free.
A Simplified Employee Pension (SEP IRA) is a retirement plan established by employers, including self-employed individuals. A SEP is an IRA-based plan that allows employers to make tax-deductible contributions on behalf of eligible employees, including the business owner.
A SIMPLE IRA is a retirement plan that may be established by employers, including self-employed individuals. A SIMPLE IRA allows eligible employees to contribute part of their pre-tax compensation to the plan. In turn, employers can match employee contributions up to 3% of said employee's compensation, or they can contribute 2% of respective compensation to each eligible employee regardless of their contribution activities.
A Solo 401(k) is like a "regular", employer-sponsored 401(k), except it's set up for an individual running a sole proprietorship or a small business with a spouse. Plan contribution limits for the individual are equal to a typical company-sponsored 401(k), but the sole proprietor can also make an employer contribution to the plan.