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Funding a Retirement Account as an Individual

With the end of the year quickly approaching, one of the things you might beginning to consider is whether it would be a good idea to open an Individual Retirement Account (IRA). There are three basic types of IRAs to be covered in this article: Traditional IRA, Roth IRA, and SEP IRA. Traditional IRAs and Roth IRAs basically operate, in terms of formation and funding deadlines, the same way. A SEP IRA will only be available to individuals who are self-employed.

First, we will cover the common elements between Traditional IRAs and Roth IRAs. In order to contribute to either a Traditional IRA or Roth IRA, you must have earned income. Both Traditional IRAs and Roth IRAs have a shared contribution limit of $6,000, with an additional contribution allowance of $1,000 if you are age 50 or older. Both can be established and funded up to April 15, 2023, following the end of the tax year, with no extensions. Which means that if you determine a Traditional IRA or Roth IRA is right for you, you have until April 15, 2023, to open the account and make contributions that count toward your 2022 tax year.

The main difference is that Traditional IRA contributions are made with pre-tax dollars, while the Roth IRA is funded with after-tax dollars. This allows funds in a Traditional IRA to be taxed only once distributions begin. In contrast, contributions to a Roth IRA will grow and are distributed tax free since the contributions have been taxed. You may be subject to additional limitations , so please check with your tax preparer or financial planner for further information.

SEP IRAs, on the other hand, operate slightly differently and have their own set of unique rules for forming and funding deadlines. A Simplified Employee Pension (SEP) IRA can be established and funded up until the due date of your tax return, including extensions. This means that theoretically, assuming you extend your tax return for the maximum time possible, you have until October 15, 2023, to both open and fund a SEP IRA for 2022. A SEP IRA operates very similarly to a Traditional IRA in the sense that they have the same investment, distribution, and rollover rules. However, there are special contribution rules allowing an employer to make profit sharing contributions to the plan. Additionally, the SEP IRA has unique contribution limit of 25% of compensation (W-2 employees) or up to 20% of net business income for recipients of pass-through income such as self-employed sole proprietors with a maximum contribution of $61,000 for 2022.