Traditional IRA's and Roth IRA's are the most popular when it comes to Individual Retirement Accounts. Which one you choose is a matter of taxes. When would you like your tax advantage? Now or later? In order to make an informed decision, it's necessary to know the difference.
IRA (Individual Retirement Account) entails several types of IRA accounts. There are Traditional, Roth, 401(k), SEP, DBP (Defined Benefit Plan), Traditional Non-deductible, and the Simple IRA. Let's start with the Traditional.
The Traditional IRA allows you to deposit pretax dollars into an account. That is, you get to your money out before the government has a chance to get there hands on it. The benefit is that the taxes on this money is deferred, so that when it's IRS time, you get a tax break. If the money is taken out early, there is a hefty penalty. The earliest that you can withdraw money from a Traditional IRA is at age 59 1/2, and the latest is 70 1/2. It's during this time that you begin to pay taxes. Before then, nothing but deductions.
The amount that can be contributed to a Traditional IRA varies. You can contribute as much as $5,000. However, if you are are 50 years of age or older, the maximum contribution is $6,000.
The Roth IRA is named after the Delaware senator, William V. Roth. He's the one who introduced the idea to Congress. With the Roth IRA, there is no tax deduction. The money is deposited from the amount left over after taxes. Some see this preferable to the Traditional because when they retire, their taxes will have been settled. Others see this as a drawback and want to benefit from deductions while they are at their highest earning potential.
If your employer has a 401(k) program, then you should be taken advantage of it. The way this works is that you, the employee, contributes a certain amount of money to the fund, and your employee will match a certain percentage of it. Ignoring a setup like this is akin to throwing away free money. Contributing your 401k reduces how much taxes you'll have to pay, because the contribution comes out of taxable income.
An SEP (Self-employed retirement Account) are for people who are self-employed. Those who are business owners receive wonderful tax breaks for SEP accounts. If you work for yourself, and you don't have anyone else working for you, the government will allow you to deposit up to $49,ooo (cost of living adjustments made yearly) or 25% of your income. The money is tax deductible, since it comes from pretax dollars.
The sooner an IRA is started, no matter which one you choose, the sooner you can began to benefit. Take a page from the way the government does things-- they make sure taxes owed to them are taken out first. Do the same when it comes to your IRA-- have it automatically deducted from your paycheck. You can't spend what you don't have, and you'll be the one to benefit.