An IRA is an abbreviation for Individual Retirement Account, and it provides individuals either a tax-deferred or tax-free way of saving for retirement. Within the world of IRAs, there are many different types of accounts, it depends on the fact that what type of financial goals and situations each individual posses, though the most common choices are traditional and Roth IRAs.
Traditional IRAs
If you are over age 50 then tax-deductible contributions of up to $4,000 per year or more are allowed by a traditional IRA. Whatever is contributed by you towards your IRA comes off your yearly income, thereby it reduces total tax liability. However, once that you have drawn the money that is in an IRA, then it is subject to standard income taxes and an additional 10% penalty if you have withdrawn it before the age of 59 1/2.
An exception can be made if the money is used by you for purchasing a house or for covering approved higher education costs. Still standard income tax is applied, but the ten% penalty is waived. By this a great investment tool is provided having flexibility for important purchases.
Roth IRAs
In 1997, Roth IRAs were created for helping middle-class Americans. These IRAs are not tax-deductible, but even greater flexibility is provided by them as compared to traditional IRAs. Without being subject to penalty or tax, contributions to the account can be withdrawn at any time, though interest is earned in the account. After five years, without penalty or taxation both contributions and earnings in the account can be withdrawn. As with the traditional IRA the same benefits concerning education and housing also apply.
Tough a Roth IRA isn’t for everyone. Individuals who file taxes using single status, as long as they don’t exceed $95,000 per year in earnings, and $110,000 for partial contributions they are eligible for full contribution. For full and partial contributions joint filers face an earnings cap at $150,000 and $160,000 respectively. For this type of IRA, high-level corporate execs need not apply.
Choosing IRAs
Depending on the financial situation, choosing IRAs can be complicated, and they may require the services of a certified financial planner. There is another important decision and that may be whether or not to rollover a traditional IRA into the new Roth IRA. Generally speaking, contributing to a Roth IRA is always more advantageous if the person is eligible, due to the fact that income taxes will not apply later when the money is taken out, provided that the person adheres to all the guidelines. But you have to make sure that there is enough time to absorb the costs of the rollover, since tax will be applied on it as if you were taking the money out of the IRA.
