When you are looking to save money for retirement, there are many options out there. Putting money toward an IRA is one of the best options for many people. Traditional IRAs and Roth IRAs are the two major IRA options that future retirees have to choose from. Here are the basics of these retirement accounts that you need to know.
Traditional vs. Roth IRA
The biggest difference between the traditional and Roth IRA options is when you are taxed for that money
Traditional IRAs are funded with pre-tax money, and they will reduce your taxable income in the current year. Then, when you take that money out to use it, you are not taxed.
Roth IRAs go into your account after the IRS taxes it. This will likely lead to a higher tax bill currently but could save you money down the road.
According to the experts at SoFi Invest, “When someone begins taking withdrawals from their account at age 59 1/2, those withdrawals are subject to income tax. Any withdrawals made before then may be subject to income tax and a 10% early withdrawal penalty.”
With a traditional IRA, you'll pay your taxes when you make withdrawals. The money goes in before taxation, and it grows tax-free. With a Roth IRA, you'll pay income tax on the front end. You'll still get tax-free growth, but since the taxes are paid when you make the contributions, you'll owe none when you withdraw your funds.
Both options allow for tax-free growth. As long as you leave your money alone, it will grow for years or decades without having any taxes deducted.
Contribution Limits and Withdrawals
Both types of IRA accounts allow for the same contribution limits. If you've not yet reached age 50, you can contribute up to $6,000 each year. Once you hit age 50, you can fund your account with an additional $1,000 per year as a catch-up contribution. This total would be $7,000 annually.
These figures are current for 2020. The contribution limits tend to increase over time because of inflation.
You can start to make penalty-free withdrawals once you are 59 1/2. With a Roth IRA, you'll owe no taxes if you've reached this age. If you're not yet 59 1/2, you'll need to pay taxes on your gains along with a 10% penalty.
Early withdrawals with a traditional IRA will lead to a tax bill at your marginal rate along with the 10% penalty. Another thing to take into consideration with a traditional IRA is the minimum required withdrawal once you hit age 70 1/2. This can lead to a hefty tax bill in your later years.
What About 401(k) Plans?
If your employer offers matching funds with a 401(k) plan, this can be a good option. The instant return can make contributing up to the match a great investment. However, when looking at Roth IRA vs 401k plans, the experts at SoFi Invest recommend opting for an IRA, depending on the investment choices your company offers.
These basics of IRA retirement accounts should help you better understand how to invest your money. Investing in an IRA is a great way to take control of your investment savings. You'll control when you pay the taxes on your retirement fund, and you'll likely have more options than you will if you choose to invest through a 401(k). However, you should also consult an expert if you are unsure of what choice to make.
Retirement may seem for away, but it's never too early to start planning! We hope this info helps.