What is an IRA?
Catch yourself saying, “what is an IRA?” Or, are you wondering what sort of retirement account you need? In just 2 minutes, learn the basics of how IRA and Roth IRA accounts work and which type of IRA might be right for you!
IRA stands for “individual retirement account.” A traditional IRA is generally tax-deductible. Thus, you can set aside money in the retirement account without paying taxes on it. If you anticipate owing taxes, it can be good to have an IRA as a way to reduce your tax liability.
Money grows tax-free in an IRA account. However, when you access IRA funds during retirement, you’ll be taxed on the money you withdraw.
For the 2016 tax year, you can put up to $5,500 aside in an IRA. If you are over age 50, you can put aside an extra $1,000. If you are self-employed or have no employer retirement plan, you can deduct the full amount of a traditional IRA deposit on your taxes.
If you have a retirement plan at work, and you earn a certain amount of income, you may be limited in the amount of IRA deposits you can deduct on your taxes. For 2016, single filers who earn $62,000-$71,999 can only deduct part of an IRA deposit, while single filers earning $72,000 and above cannot deduct traditional IRA deposits.
What is a Roth IRA?
Like the IRA, the Roth IRA allows individuals to save for retirement. Roth IRAs have the same financial limits as traditional IRAs. However, the Roth differs in one key are: taxes. You pay taxes on money when you place it into a Roth IRA, the money grows tax-free, and you get to withdraw your money upon retirement without having paying taxes, since those funds have already been taxed.
If you earn over $133,000 as a single individual, you cannot open a Roth IRA. Roth eligibility phases out at $118,000.
Which Type of IRA is Right for You?
Ultimately, the decision of whether to open a traditional or Roth IRA depends on whether it’s in your best interests to pay taxes now or later. If you have low tax liability, you may not need the benefit of deducting an IRA deposit. Thus, a Roth IRA account could be the better choice, since it may be advantageous to you to have retirement earnings that you do not have to pay taxes on down the road.
If you expect to owe money in taxes, you may prefer to reduce your liability now, through a traditional IRA. If you are self-employed or a high earner, you may find a traditional IRA the more attractive choice.
While young adults generally earn less (thus are taxed at a lower rate than older persons), there is no hard and fast rule. Determine for yourself which option makes the most sense for you.
Finally, there’s no rule saying you can have only one IRA account. You can open both a Roth and traditional IRA, and make contributions to both accounts.