What Is an Individual Retirement Account?
Individual Retirement Accounts come in several flavors. Investors can either choose a traditional Individual Retirement Account, also known simply as an IRA, or they can choose the tax free Roth IRA version. Many first time investors are often confused about what exactly an Individual Retirement Account and the difference between a Traditional IRA and Roth IRA.
What Is An Individual Retirement Account?
An Individual Retirement Account is a type of retirement plan offered in the United States to investors that provides tax advantages to an investor. An IRA is not an investment on its own but rather a tax classification of other investment accounts. Traditional and Roth IRAs can both be invested in different securities such as stocks, bonds, mutual funds, certificates of deposit, and other investments. Investors can use the tax advantages of IRAs to invest in investments such as real estate, derivatives, commodities, and a host of other investments that may not seem like a traditional retirement investment.
The Tax Differences of a Traditional and Roth IRA
The difference between a Traditional IRA and a Roth IRA primarily surrounds the when taxes are paid on the investment. Traditional IRAs are tax deferred investments where taxes are paid when the investment and earnings are withdrawn later in retirement. Roth IRA, on the other hand, is a tax exempt investment account. With a Traditional IRA, an investor’s taxable income is reduced dollar for dollar what is invested in the retirement account, and taxes are paid on the entire sum when withdrawn. Taxes are paid on the money invested into a Roth IRA before the investment is made, and then all principle and interest can be withdrawn in retirement tax free.
Other Differences of a Traditional and Roth IRA
Traditional IRAs and 401k retirement plans require investors to begin withdrawing their investments at the age of 70 ½. Roth IRAs have no such mandatory withdraw requirements. Another big difference of a Traditional IRA and a Roth IRA is the tax deduction. A Traditional IRA allows investors to deduct the amount of money that they invest from their taxes. A Roth IRA does not provide a tax deduction for investors.
One of the biggest drawbacks of a Roth IRA is that there are strict contributions limits for investing in the plan. A Traditional IRA is available to all investors regardless of how much they earn throughout the year. In order to be eligible for a Roth IRA, single investors can only earn $105,000 or less to qualify to invest the full contribution limit. If the single investor earns between $105,000 and $120,000, he or she can contribute a smaller amount than the full $5,000 contribution limit. For joint tax filing couples, the income level limit is $167,000 or less to qualify for eligibility to contribute the full amount, $5,000 per account holder or $10,000 per couple. The entire eligibility phases out after the couple earns more than $177,000 throughout the year.
There are many differences between the Traditional IRA and the Roth IRA. The most important implication to understand is the tax consequences of both plans which comprise the biggest difference between the two retirement plans. Investing for retirement is one of the most important financial decisions that investors make, and choosing the right Individual Retirement Account can make a lot of difference.
Hank Coleman is the founder of several financial blogs, focusing on topics such as how to select the appropriate individual retirement account for you. He is an entrepreneur and professional in the government sector. Hank holds a Bachelor’s degree in Business Administration, a Master's in Finance, and is currently studying for his Certified Financial Planning (CFP) credentials. Always looking for a trusted financial institution for advice and tips he tends to look up information at http://www.discoverbank.com more often than not. To read more at http://www.discoverbank.com/ira-cd.html