An individual retirement account (IRA) is a retirement savings account available to individuals in the United States. An IRA allows you to save for retirement and potentially earn investment returns on your savings. There are two main types of IRAs: traditional IRAs and Roth IRAs. In this article, we’ll look at each type of IRA and discuss its benefits and drawbacks.
Traditional IRA
A traditional IRA is a retirement savings account in which you make contributions on a tax-deferred basis. This means that the money you contribute to your traditional IRA is not taxed until you withdraw it in retirement. Traditional IRA contributions may also be tax-deductible, which can help reduce your taxable income in the year you contribute.
There are some restrictions on who can contribute to a traditional IRA. For example, you must have earned income to contribute and cannot contribute more than a certain amount each year. In addition, in 2023, the contribution limit for traditional IRAs is $6,000 for individuals under age 50 and $7,000 for those aged 50 and older.
One potential downside of a traditional IRA is that withdrawals are subject to income tax. When you withdraw money from your traditional IRA in retirement, you must pay income tax on the amount you start. Additionally, if you withdraw money from your traditional IRA before age 59 1/2, you may be subject to a 10% penalty on top of any income tax due.
Roth IRA
A Roth IRA is another retirement savings account available to individuals in the United States. Unlike a traditional IRA, contributions to a Roth IRA are made on an after-tax basis. This means that you pay income tax on the money you contribute to your Roth IRA in the year you contribute. However, the earnings on your Roth IRA investments grow tax-free, and withdrawals in retirement are also tax-free.
Like traditional IRAs, there are restrictions on who can contribute to a Roth IRA. For example, your income must be below a certain level to contribute to a Roth IRA. In 2023, the contribution limit for Roth IRAs is the same as for traditional IRAs: $6,000 for individuals under age 50 and $7,000 for those aged 50 and older.
One potential downside of a Roth IRA is that contributions are not tax-deductible. This means you won’t receive a tax break for contributing to your Roth IRA in the year you contribute. Additionally, suppose you withdraw money from your Roth IRA before age 59 1/2. In that case, you may be subject to a 10% penalty on the earnings you withdraw (although you can withdraw your contributions at any time without penalty).
Which IRA is right for you?
Deciding between a traditional IRA and a Roth IRA depends on your circumstances. However, here are some factors to consider:
- Tax bracket: If you’re in a high tax bracket now and expect to be in a lower tax bracket in retirement, a traditional IRA may be a better choice since you’ll pay less tax on your withdrawals in retirement. If you’re in a low tax bracket now and expect a higher tax bracket in retirement, a Roth IRA may be a better choice since you’ll pay tax on your contributions now when your tax rate is lower.
- Age: If you’re younger and have many years before retirement, a Roth IRA may be a better choice since your earnings will have more time to grow tax-free. A traditional IRA may be a better choice if you’re closer to retirement age since you can take advantage of the immediate tax deduction for your contributions.
- Income: If your income is below the threshold for Roth IRA contributions, a traditional