It’s important to start saving early for retirement. The good news is, even if you already are earning a 401(k) at work, you can give your savings a boost with the help of an Individual Retirement Account (IRA).
An IRA, which combines the benefits of both compound interest and tax savings, is an investing tool individuals use to earn and earmark funds for retirement savings.
You are to able to open an IRA at virtually any financial institution, including your bank account, and the opening fees are typically lower than any other investment accounts.
It can be confusing figuring out what type is best for you while an IRA is relatively easy to open.
There are two types of IRAs-traditional and Roth.
With a traditional IRA, your earnings are taxed when you start making withdrawals, and you generally incur a penalty if you withdraw money before the age of 59 and half. For example, if someone contributes $5,500 to his or her IRA, he or she can claim that amount as a deduction on his or her income-tax return, and to those earnings income tax will not be applied by the Internal Revenue Service.
With a Roth IRA, you can withdraw your earnings tax-free after age 59 and half as long as you’ve had the account for at least five years. In other words, earnings from a traditional IRA are tax deferred, while for Roth IRA, the earnings are tax exempt. This means you contribute to a Roth IRA with after-tax dollars, but as the account grows, you do not face any taxes on capital gains. Without incurring any income taxes on your withdrawals, you can withdraw from the account when you decide to retire.
Another important difference is that you must begin taking withdrawals from a traditional IRA at the age of 70 and half. There is no mandatory distribution age in the case of Roth IRA, but there are certain income restrictions. Single filers with adjusted gross income of $110,000 or more and couples whose joint return is $160,000 or more cannot open a Roth IRA. Traditional IRAs, on the other hand, have no such kind of income restrictions.
That explains a little about the money you take out of an IRA, but what about the money you put in? Contributions made on a traditional IRA may be tax deductible depending on the level of your income, but if you are eligible to participate in your employer’s retirement plan; it may not be possible for the deduction of all of your contributions. On the other hand, Roth IRA contributions are never tax deductible, but earnings are tax-free if those earnings are the part of a qualified distribution.
New IRA contribution limits are being imposed by the federal government each year. It is generally a good idea to make the maximum contribution you possibly can. The good news is that the contribution limits have gone up since 2002 and continue to increase, so there’s never been a better time to open an IRA.