Saving for retirement should not be a tough nut to crack. Just ask your neighborhood squirrel – who innately understands how to save for the future. Well, you should think of an IRA account the same way. An IRA (individual retirement account) is a savings account that allows you to sock away cash for retirement – with big tax breaks as an enticing incentive.
Here’s what you need to know about IRAs. There are two types of IRAs – the traditional and the Roth IRA. Simply put, a traditional IRA enables you to save pre-tax money today and delay taxes until you take the money out. With a Roth IRA, your contributions are made with after-tax dollars but there are no taxes when you withdraw the funds at retirement. When deciding between a traditional IRA and a Roth IRA, you can think of it as Uncle Sam asking, “Do you want to pay me now or pay me later?”
In the traditional IRA, you only pay tax on your IRA savings account when you withdraw funds for your retirement. At the time of withdrawal, this money is taxed as ordinary income. The advantage of a traditional IRA is the money you invest which is used to buy stocks, bonds, mutual funds and other assets, goes in pre-tax and grows tax-free. But the taxman cometh when you begin to withdraw funds. Baby boomers take note – the cutoff date to contribute to your traditional IRA account is 70-and-a-half. That is also the age where you are required to start taking withdrawals.
In a Roth IRA, the funds also grow tax-free but the tax benefit situation is reversed. The money you put into your Roth IRA investment basket is not tax deductible. The good news – you will never owe any tax when you withdraw money for retirement, as long as you follow the rules. There are fewer restrictions on timing of withdrawals from a Roth IRA, too. The Roth IRA is a powerful retirement savings vehicle, the benefits of which are not utilized often enough by investors in my view. The benefits are so attractive for both IRAs and Roth IRAs that high earners are limited in their contributions.
If you have questions about the tax benefits of an IRA or a Roth IRA and which is the right option for you – please call me. Don’t face retirement with the feeling the only exercise you have ever done is running out of money.
1. The Roth IRA originally started with the Tax Relief Act of 1997, named after late Senator William Roth of Delaware.
2. IRA was introduced with the Employee Retirement Income Security Act of 1974 (ERISA) and made popular with the Economic Recovery Tax Act of 1981.