An individual retirement account (IRA) is a tax-advantaged retirement savings account available to U.S. taxpayers. IRAs allow individuals to save for retirement while deferring taxes on their contributions and earnings.
There are two main types of IRAs: traditional IRAs and Roth IRAs, and we’ll explore on both of them for you to have a better understanding of these retirement options. It’s never too late to start saving for your golden years, so do it now.
Traditional IRAs or Roth IRAs: What’s Better for Your Retirement?
Traditional IRAs allow individuals to deduct their contributions from their taxable income. This can provide a significant tax savings, especially for taxpayers in high tax brackets. Traditional IRAs also offer tax-deferred growth, meaning that earnings are not taxed until they are withdrawn in retirement.
On the other hand, Roth IRAs do not offer a deduction for contributions, but withdrawals are tax-free in retirement. This can be a valuable option for taxpayers who expect to be in a higher tax bracket in retirement than they are now. Roth IRAs also offer tax-free growth, just like traditional IRAs.
The contribution limits for IRAs are set by the IRS. For the current fiscal year, the contribution limit for traditional and Roth IRAs is $6,000 for individuals under age 50 and $7,000 for individuals age 50 or older. Individuals with modified adjusted gross incomes (MAGI) above certain thresholds may be subject to income limitations on their IRA contributions.
Early Withdrawal Penalties: Don’t Touch Your Retirement Money
There are penalties for withdrawing money from an IRA before age 59½. The penalty is 10% of the amount withdrawn, plus income taxes on the withdrawal. There are some exceptions to the early withdrawal penalty, such as for qualified education expenses, first-time homebuyer expenses, and certain medical expenses.
IRAs can be rolled over from one type of IRA to another, or from an IRA to a qualified employer-sponsored retirement plan. Rollovers can be a good way to consolidate your retirement savings or to take advantage of the tax benefits of a different type of IRA.
Withdrawals from traditional IRAs are taxed as ordinary income. The amount of tax you owe will depend on your income tax bracket when you make the withdrawal. Withdrawals from Roth IRAs are tax-free, but you may owe income taxes on any earnings that were not taxed when you made your contributions.
IRAs can be a valuable part of your retirement plan. They offer tax advantages that can help you save more for retirement. If you are eligible to contribute to an IRA, it is a good idea to consider doing so.