Which IRA Is Best For Me?


Which IRA Is Best For Me?

What Is An IRA?

Generally speaking, an IRA is an Individual Retirement Account. The two I will speak about in this section are the Traditional IRA and the Roth IRA. These two IRAs have both income limits, and contribution limits (outlined below). In general, you can make contributions into these accounts while you are earning income (provided you meet the requirements below), and you cannot take out the money until you are at least 59 years old (there are certain circumstances where you can get to the money early). People typically invest in these accounts as a retirement tool because they offer certain tax advantages that other normal stock, mutual fund, or cash accounts do not offer. In general, these accounts are a part of nearly every retirement plan provided that you qualify for the funds, you have enough money to invest in them, and you don’t need the money until retirement.

Traditional IRA
This type of account has contribution limits (under the 2010 rules, you could invest $5K/year if you are 49 or younger, and $6K/year if you are 50 or over). This type of account also has income limits, so you should check to see if you make too much money to qualify (2010 limits ranged between $56K – $66K for single filers, and between $167K – 177K for joint filers, meaning that if you made less money than the low-end of the range you could invest fully in the account, and if you fall somewhere in the range you may be able to invest a portion of the limits into the account).

There are two major benefits of this type of account: Tax-Deferred Gains, and the contributions are Tax-Deductible. Tax-Deferred means is that if your $3,000 contribution grew at 10% for 20 years, you would then have just over $20,000 without ever paying a dime of taxes. You will only be taxed on the income when you withdraw the money during retirement. By not paying taxes throughout your working years, the money accumulates much quicker, and your retirement pot grows more rapidly. Tax Deductible contributions mean that if you put in $3,000 dollars, you will actually get to write off $3,000 off of your taxable income for the current tax year. For example, if you are in the 15% tax bracket, you would owe approximately $450 less in taxes if you made a $3,000 contribution. Between these two advantages, this account is generally a great match for anyone who qualifies for this account.

Roth IRA
This type of account has contribution limits (under the 2010 rules, you could invest $5K/year if you are 49 or younger, and $6K/year if you are 50 or over). This type of account also has income limits, so you should check to see if you make too much money to qualify (2010 limits ranged between $105K – $120K for single filers, and between $167K – 177K for joint filers, meaning that if you made less money than the low-end of the range you could invest fully in the account, and if you fall somewhere in the range you may be able to invest a portion of the limits into the account).

There are two main differences between the Roth IRA and the Traditional IRA: The Roth IRA grows Tax-Free, and the contributions are not Tax-Deductible. Tax-Free means is that if your $3,000 contribution grew at 10% for 20 years, you would then have just over $20,000 without ever paying a dime of taxes. You will then not be taxed at all on the income when you withdraw the money during retirement. By not paying taxes throughout your working years, the money accumulates much quicker, and your retirement pot grows more rapidly. By not paying taxes when you withdraw the money, you save an enormous amount of money during retirement. Since the contributions are not Tax Deductible, this means that if you put in $3,000 dollars, you will not be able to write off any tax dollars for the current tax year.

Which One Is Best For Me?

Speaking in general terms, if you are under 45 and you qualify for a Roth IRA, then it is usually a better long-term investment. This is because you have enough time left before retirement to make the tax-free growth worth more than the tax-deduction you would get if you were to write off a contribution to your traditional IRA. The exception to this would be if you are in need of a tax deduction or have another reason to lower your overall tax liability.

If you are above 45, you may want to consider the Traditional IRA, take the tax-deduction in the current tax year, and pay the taxes on the withdrawals later on during retirement. The exception to this would be if you are not planning on withdrawing the money until deep into retirement, in which case you can still look at a Roth IRA for the benefits mentioned above.

Retirement Junkie is a website that the Hagopian Institute put together as a source for free information to help people prepare for retirement.  Please visit retirementjunkie.com, and follow MrEmergingMedia on Twitter for more retirement tips, along with other fun offerings from Todd Hagopian and the Hagopian Institute.

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About Todd Hagopian (@ToddHagopian)

Todd Hagopian received his BA from Eastern Michigan University with a major in Political Science. After graduation, he worked as a Financial Advisor and a Bank Manager before returning to school. He attended Michigan State University, where he completed an MBA with a double-major in Finance and Marketing. Todd is now a Senior Product Development Manager for a Fortune 500 company. He frequently writes about business issues, social media strategy, and political issues that he finds important. Enjoy the blog!

Posted on December 7, 2011, in Investing and tagged , , , , , , . Bookmark the permalink. Leave a comment.

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