The traditional IRA, the largest statesman of IRAs, remains the most popular of the individual tax-advantaged retirement savings accounts, according to data from the Investment Company Institute. There are three types of IRA. Understanding the difference will help you determine the best option for your retirement savings goals. The main difference between a traditional IRA and a non-deductible one is the ability to deduct annual contributions from your income taxes.
Contributions made to a non-deductible IRA are taxed as ordinary income in the year they are deposited and cannot be deducted from gross income. So the moment you withdraw funds from a non-deductible IRA, you only pay income taxes on earnings, since your annual contributions are already taxed. The main advantage of this type of IRA is the growth in tax-deferred contributions and profits. Non-deductible IRAs offer an investment option for people who don't meet the eligibility criteria for a traditional IRA or for those whose adjusted gross income exceeds the Roth IRA limits.
The two main reasons to use a non-deductible IRA are because you are not eligible for a deductible IRA (most of the time because your income exceeds the maximum limit) or because you prefer to collect your tax savings when you retire, once you start withdrawing funds. This is the topic you've probably heard the most about in recent years. The Roth IRA was established in 1998 and is very different from traditional, non-deductible IRAs. Contributions to a Roth IRA are taxed as income in the year they are deposited, similar to a non-deductible IRA.
Therefore, contributions cannot be taken as tax deductions. However, at the time of withdrawal, profits from those contributions are not subject to taxation. After age 59, you can withdraw all or part of a Roth IRA without paying income taxes and without penalty. As with other IRAs, unqualified withdrawals are subject to a 10 percent penalty.
Unlike the other two types of IRAs, there is no requirement that dictates when funds should be withdrawn from a Roth IRA. For example, the entire account can be left in the hands of your heirs without penalty. Tax-free withdrawals would be more useful for someone who ends up in a higher tax bracket once they retire. It's also much easier to use Roth IRAs before you retire.
So, while it's rarely a good idea to tap into your retirement savings before you retire, if you think you may need to finance the purchase of a home or a high school education, the Roth IRA gives you more flexibility. While deductible, non-deductible and Roth IRAs are the dominant options, there are some important variants you should be aware of. Generally, you need an income before you can contribute to an IRA. However, if you're married and your partner has an income, but you don't (or your income is too low), you can still open your own traditional or Roth IRA.
The account must be opened in the name of the spouse who does not earn money, but can be financed with money earned by the other spouse. The two main types of IRAs are traditional IRAs and Roth IRAs. There are also two other types of IRAs that offer advantages similar to the others if you happen to be a small business owner or sole owner, are self-employed, or engage in any other form of self-employment. These plans are designed to be simple, with low fees and basic administration.
. Variations of the most common types of IRAs include inherited IRAs and custodial IRAs. Each IRA has its own characteristics that you should evaluate when setting your retirement savings goals. Your account will be managed by a broker or other agent of the firm who will invest your money in CDs, bonds, mutual funds, stocks and almost any other type of asset in the market.
You can open an IRA account at a bank, brokerage firm, mutual fund company, or insurance company, or several other types of financial institutions. The SEP IRA offers tax benefits to an employer who deposits money into this type of account on behalf of an employee. Depending on the type of IRA you use, an IRA can lower your tax bill when you make contributions or when you withdraw money when you retire. There are a wide range of options in IRAs regarding the types of holding, as well as how practical or practical you prefer to be.
IRAs can be comprised of mutual funds, stocks, bonds, bank deposit accounts, and most other types of investments. Just keep in mind that the rules governing these types of actions are very precise with regard to the way your income is counted and may affect your taxes. Depending on the type of account you have, there are different rules for withdrawals, penalties and distributions. Tax law provides for many types of IRAs, each designed to help you save for retirement and taxed in its own way.