If you are looking to diversify your retirement savings or if your workplace has already contributed all of your money to an IRA, you should consider opening an individual retirement account (IRA).
There are two types of IRAs: the Roth and the traditional. However, key differences in withdrawals and contributions can make it difficult to choose which plan is best for you.
Both cases allow maximum annual contributions of $5.500 until the person reaches age 50. After that, contributions increase to $6.500 depending on your income or marital status.
Roth IRAs allow you to pay taxes on any contributions made before they are placed into the account. This is called an aftertax contribution. It is a great investment choice for young savers because it pays taxes on contributions before they are placed in the account (called an aftertax contribution). A traditional IRA doesn’t have to pay taxes until you withdraw the funds in retirement. This is called a pretax contribution.
However, if a younger person is starting their career in a lower tax bracket then he or she will finish it, he or she can contribute to an aftertax Roth IRA sooner than he or they will finish it. This will likely give them a tax advantage. For older savers, however, it may be more beneficial to contribute to a traditional IRA to allow them to deduct their income taxes.
“Most young adults earn less in their early years of their careers than they do in retirement. A Roth IRA allows them to take advantage of a lower tax bracket, potentially avoiding higher tax rates when they start distributing funds from retirement accounts. Jared Parks, a financial advisor, told CBS MoneyWatch.
It also protects against higher income tax rates when a person retires.
The average time it takes for the Roth account to pay back the initial tax payments is 10 years. A traditional IRA is a good option for people over 50 because you can deduct contributions from your taxes.
It’s easy to see: If you put $5,500 per year in a Roth IRA starting at age 30, and assume a 7 percent annual return, you will have $241,000 by the time you reach age 50. This is $130,000 in tax-free earnings.
You can expect to invest $5,500 per year in a traditional IRA for the same time horizon. This is $36,000 less than you would pay taxes.
The Roth also offers another advantage: You can withdraw any initial contributions tax-free. However, the accrued (or earned) money cannot be withdrawn before you reach age 59 1/2. Unless you are eligible for early distributions, traditional IRAs will have to pay taxes on all earnings and contributions.
A Roth IRA is a great way to save money for first-time homebuyers. The Roth IRA allows first-time homebuyers to take $10,000 from their Roth earnings and use it for a down payment.
Steve Wright, a financial advisor, wrote an email to CBS Moneywatch stating that a traditional IRA would allow you to withdraw $10,000 without penalty and that the total amount would be taxable at their normal income rate.
It is important to use retirement funds for other financial purposes. This will reduce the compounding interest that accumulates over time. You should carefully consider your financial goals before withdrawing funds too early.
