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Looking for a place to park, invest, and grow your retirement dollars? An Individual Retirement Account (IRA) is an account that lets you protect your retirement money and save on taxes. Unlike a 401(k) plan, which can only be set up by your employer, you can set up either a traditional or Roth IRA yourself.
To do so, you must have a source of taxable income and complete some mandatory paperwork. Most banks and investment firms will help you with the set-up process.
I have a Roth IRA through Vanguard, one of the world’s largest and most trusted investment firms. However, you have plenty of options, including TD Ameritrade, Scottrade, Fidelity, or through your bank of choice.
The difference between traditional and Roth IRAs
First, you should understand the difference between a traditional and a Roth IRA. The main difference between the two is in the income limitations and restrictions. With a traditional IRA, anyone younger than 70½ years old with any income can contribute. There are no income limitations for the traditional route.
With a Roth IRA, if a single tax filer’s adjusted gross income is less than $117,000, they can contribute. From $117,000 to $132,000 a single filer can make a partial contribution. For incomes greater than $132,000, individuals are ineligible to contribute.
The adjusted gross income limitation for a married couple to make a full contribution is $184,000. From $184,000 to $194,000, partial contributions are a viable option. Over $194,000 of joint income, and the married couple is no longer eligible to contribute.
Regardless of what type of IRA you choose, there is a maximum annual contribution limit. At time of writing, individuals under the age of 50 can contribute $5,500 to a retirement account. For those over the age of 50, that number jumps to $6,500.
The truth about taxes
Both types of accounts offer hefty tax breaks. Traditional IRAs are tax deductible on your state and federal income tax returns, but once you retire and withdraw the money, you’re taxed at whatever your existing tax rate is.
With a Roth IRA, your contributions are taxed at your regular rate, but aren’t taxed when you withdraw the money during your retirement. In short, you’re taxed when you withdraw money with a traditional IRA and taxed when you add money with a Roth IRA.
The rules of withdrawal
Contributions you make directly to your Roth IRA can be withdrawn without taxes or penalties at any time you wish. With a traditional retirement account, you can only withdraw money without penalty after age 59½. Withdrawals after that age are treated and taxed like ordinary income.
Before choosing either type of IRA, decide when you’re best able to afford paying taxes on that money.
There are many ways to save for your retirement. Either type of retirement account offers time-tested individual retirement accounts, each with varying, but workable rules and regulations. An IRA, whether Roth or traditional, can be very beneficial in your retirement years.
I personally decided to go with a Roth IRA, because I anticipate my salary (and therefore my tax rate) to go up as I get older. Thus, I’d rather pay taxes now, since they will be less.
IRAs are invested
Since IRAs are invested, they will continue to grow over time via the magic of compound interest. Which means that the earlier you get started, the more time your money will have to grow, and the more you will have come retirement.