IRA is the abbreviation of The Individual Retirement Arrangement. It has been available since 1974. The IRA has great potential as an accumulation device for retirement when started early and funded annually. The compound growth potential of such accounts often makes the tax deductibility of the contribution a less significant issue than the accumulation.
IRA is basically a personal savings account with big tax breaks, making it an ideal way to sock away cash for individual retirement. A lot of people mistakenly think an IRA itself is an investment - but it is just the basket in which an individual keeps stocks, bonds, mutual funds and other assets.
Unlike 401(k)s, which are accounts provided by employees’ company, the most common types of IRAs are accounts that people open on their own. Others can be opened by self-employed individuals and small business owners.
There are two general types of individual retirement arrangements (IRAs) under present law: * traditional IRAs, to which both deductible and nondeductible contributions may be made; * Roth IRAs, to which only nondeductible contributions may be made. So understanding each account and their differences helps an individual determine which IRA is best for his financial situation and retirement plans.
Traditional IRA Basics
A traditional IRA is a personal retirement savings account held at a bank or a brokerage firm that can be funded with investments such as stocks, bonds and mutual funds offered through the financial institution where individual account is held. Traditional IRAs provide tax savings, including tax-free growth of earned interest, dividends and capital gains while the money is in the account. An individual also usually claims a tax deduction each year that he makes a contribution to a traditional IRA. While his contributions to a traditional IRA are not taxed, he has to pay taxed when he remove the funds from the account at retirement.
Roth IRA Basics
A Roth IRA is a personal retirement savings account also held at a bank or brokerage firm that can be funded with a wide variety of investments, including stocks, bonds and mutual funds. Roth IRAs also offer tax savings, including tax-free growth of earned interest, dividends and capital gains while the money is in the account, but An individual is not taxed when he withdraws the money. Withdrawals of contributions are tax free after the Roth IRA has been open five years, and individual can withdraw investment earnings tax free after he reaches the age of 591/2.
Traditional IRAs vs. Roth IRAs
When it comes investments, traditional and Roth IRAs work the same way. An individual funds the IRA and then moves the money into various investments. With both types of accounts, the interest, dividends and capital gains grow tax free. If an individual is employed and earning an income, he can currently contribute to both types of accounts up to $5,000 per year until the age of 49 and $6,000 per year if he is 50 or older. Contributions to either type of IRA must come from taxable income earned from working. Earned income also includes alimony received by the taxpayer. For federal income tax purposes, alimony is deductible by the payor and is includible as earned income by the recipient. The following table provides the similarities of traditional IRA vs. Roth IRAs. | Traditional IRA| Roth IRA|
Earned Income| √| √|
Investment Choices| √| √|
Prohibited Transactions| √| √|
However, there are several important differences between traditional and Roth IRAs. Consider the following differences when making a decision regarding which type of IRA is right for your financial situation. Tax Deferral
Traditional IRA: Contributions are taxed at the prevailing tax rate when money is taken from the account at retirement. Individual contributions are not taxed when he initially deposits them into his account. Roth IRA: Because individual...