When you start saving for retirement, you’ll find that a number of investment accounts are set up to aid you in that regard. You’ll also find that one type of account financial experts recommend a lot is a Roth IRA. What is a Roth IRA, though? What advantages does it offers? Also, how many different kinds of IRAs are out there?
In order to explain what a Roth IRA is, you need to know something about IRAs in general. IRA stands for “Individual Retirement Account,” a type of savings account designed to help you put money aside for retirement. These accounts let you buy investments, such as individual stocks and mutual funds, but they also give you tax breaks, which can potentially save you thousands of dollars.
Several different types of IRAs exist, but the two primary types are the traditional IRA and the Roth IRA. Both types of IRAs allow you to put aside money for retirement in addition to any 401(k) or workplace savings plan to which you are contributing. The contributions you make to both types of IRAs are also tax deductible.
The biggest difference between a Traditional IRA and a Roth IRA comes down to when your contributions are taxed. With a traditional IRA, the contributions you make to the account are tax deductible up to the IRS limits. You only have to pay income taxes once you start withdrawing funds from your IRA.
Contributions to a Roth IRA, on the other hand, are not tax deductible. However, once you reach the age of retirement you can withdraw the money in your account tax-free. What this means is that any money your contributions earn, like through compound interest, won’t be taxed when you withdraw it.
As you might guess, the Roth IRA is especially valuable to younger people saving for retirement. If you can put money into a Roth IRA savings account and wait a few decades, by the time you’re ready to retire you can potentially get thousands of dollars tax free.
Another important difference is when you’re required to start drawing funds out of your IRA. With a traditional IRA, you have to start taking out a certain amount of money, known as a required minimum distribution (RMD) at age 70 ½. You have to withdraw the money (and pay taxes on it) whether you need the money or not.
A Roth IRA, though, does not require you to withdraw money at all. In fact, if you’d like, you can even leave the Roth IRA to your heirs, which makes a Roth IRA an ideal way to transfer your wealth.
While a Roth IRA can be very beneficial, you should also be aware of its limitations. The biggest limitation is that you can only contribute so much to it each year, and the contribution limit for a Roth IRA is lower than the limit for a 401(k).
You should also know that a Roth IRA has an income eligibility limit. If you make too much money, you can no longer contribute to an IRA. However, the income limit is over $100,000, so the odds are good most people will be able to contribute.
A Roth IRA can give you a huge advantage when saving for retirement, especially if you start early. If you want to open a Roth IRA, contact First Alliance Credit Union. You can open a Roth IRA for as little as $10.00, and there is no annual maintenance fee or service charge.