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Understanding the Individual Retirement Account (IRA)

Understanding the Individual Retirement Account (IRA)

It’s never too early to start saving for retirement. In addition to a 401(k), an IRA is another great way to save for your future. An IRA is a savings account with tax advantages that individuals can use to save and invest long term. Traditional and Roth are two of the most commonly known IRAs, with the biggest difference being how and when your money is taxed. Both are good retirement accounts to consider and offer many investment options.

Traditional vs. Roth
There are several key differences to keep in mind when determining which option is best suited for your situation. With a Traditional IRA, contributions are tax-deductible, but withdrawals in retirement are taxable. This option is best suited for a person that would be in the same or lower tax bracket when you start taking withdrawals. With a Roth IRA, contributions are not tax-deductible, but the withdrawals in retirement are tax-free. This is best suited for a person who expects to be in a higher tax bracket when you start taking withdrawals.

You can own both types of IRAs, however your total deposits must not exceed the overall IRA contribution limit for the tax year.

Contribution Limits and Distribution Rules
Both IRAs have the same contribution limits, which are set annually. For 2021, you can contribute up to $6,000 if you are under 50, and up to $7,000 if you are 50 or older. If you’re married, you and your spouse can each contribute $6,000, for a total of $12,000.

With a Traditional IRA, at age 72, it is mandated that you take required minimum distributions (RMDs). With a Roth IRA, there is no requirement for the RMDs at any age.  

Early Withdrawals
Traditional IRAs: If you withdrawal funds prior to 59 ½, you are taxed at your current income tax rate and will incur a 10% early withdrawal tax penalty.

Roth IRAs: If you withdrawal funds prior to age 59 ½ it depends on whether it’s your contributions or your earnings that you’re tapping into. Withdrawing contributions at any age is tax and penalty-free. Withdrawing earnings before 59 1/2, however, incurs a 10% early withdrawal penalty and may be subject to income taxes like with a Traditional IRA. With a Roth IRA, there are exceptions to the early withdrawal penalty for the following: first-time home purchases, college expenses and birth or adoption expenses.

Overall, if you are thinking you may need to access the funds early, it’s probably best to consider a Roth IRA.

Why you should open an IRA.
They offer tax-free growth on your investments, so you won’t be taxed on dividends or capital gains while the investments are in your account. Reach out to one of our offices today. We’d be happy to discuss which option is best for your needs.