Are you considering opening an Individual Retirement Account? There are several types to choose from, but the two most common are Traditional and Roth IRAs. Both are excellent savings opportunities, but they vary in several ways.
Tax Deferred versus Tax Free Earnings
A traditional IRA allows you to save non-taxed income for your retirement. When you contribute to this type of account, the amount is deducted from your yearly taxable earnings. This allows you to defer taxes on this money and to grow it tax-free until your retirement.
Funds deposited into a Roth IRA are taxable in the year contributed. This means you will pay taxes on all of your income. The benefit to a Roth IRA is that you do not have to pay taxes later when you withdraw the money. This allows you to pay your taxes at a tax level you already know about, versus waiting to see what future taxes may be.
Both Traditional and Roth IRAs allow you to control your investment options. You can invest your retirement account in stocks, bonds, money markets and many other opportunities. There is no difference in how you can invest either of these accounts.
If you have a traditional account, you cannot make any early withdraws without receiving a penalty fee. You cannot even touch your principal investment. With a Roth IRA, however, you can take out your initial investment if you need it. Beyond the principal amount, any other early Roth withdraws will be penalized. With both types of accounts, there are special circumstances that may apply to allow you to avoid the 10% penalty for withdrawing funds early.
With both types of IRA accounts, you can begin to receive distributions at age 59 ½. If you have a Traditional IRA, you are required to begin withdraws by age 70 ½ if you have not already done so. There is no mandatory age for distribution if you have a Roth IRA.
Traditional IRAs are a more common option because anyone can use this type of account and there is no earnings requirement. If you wish to open a Roth IRA you must earn at least 95,000 a year if you are single or 150,000 if you are married.