When choosing a deductible IRA, there are three major choices available to you: a Roth IRA, a traditional IRA and a self-employed or SEP IRA. Choosing the right IRA involves considering your tax rate both now and in the future. It also involves evaluating what your income is, where that income comes from and how much you wish to invest.
A traditional deductible IRA allows for tax deductions to be made when the money is invested. For example, if you invest in the year 2010, you can deduct the amount invested off of your 2010 taxes. This allows you to invest with pre-tax dollars. There is a limit on how much can be invested annually in a traditional IRA, which is adjusted periodically, and those whose income exceeds a certain level are not permitted to invest in a traditional deductible IRA at all.
A Roth IRA, on the other hand, does not permit you to deduct the money in the year when the contribution is made. It is, however, still considered to be a tax advantageous investment because the earnings within the account grow tax free. This means when it comes time to withdraw the money after you have retired, you may take out money without paying taxes on it. Like a traditional deductible IRA, there is both a contribution limit and an income limit for those wishing to invest.
A SEP IRA is specifically designed for those who earn their income from self employment. A SEP IRA removes the income limits that are in place on traditional and Roth IRA accounts and sets the investment limits much higher in many cases, as the limits are based on your annual income in the year you are investing. It is also an account that allows for investments to be made pre-tax. Because the investments are made with pre-tax dollars, when you withdraw money, you pay taxes on the withdrawals.
To choose the best deductible IRA, you must first determine whether you qualify to invest in either a traditional or a Roth based on your income; if not, and if you are self-employed, a SEP IRA may be your only option. You must next determine whether you believe your tax bracket will be higher now or after you retire. If you expect your income — and thus your tax bracket — to go down after you have retired, then a traditional IRA or a SEP IRA may be a better choice.
