Which IRA is Best for Me?

 Which IRA is Best for Me?

 

 

            Before we begin, you may be wondering what an IRA is. IRA stands for Individual Retirement Account. These accounts provide a way for individuals to save for retirement while receiving tax breaks for doing so. While there are several different types of IRAs. The two most popular are the Traditional IRA and the Roth IRA.

 

            The Traditional IRA has rules set up like a 401K. Traditional IRAs are tax deductible, meaning that if someone were to put $6,000 into their Traditional IRA, then they can deduct that $6,000 from their taxable income at the end of the year. When you begin to withdraw from your Traditional IRA at retirement, you will pay income taxes on the withdrawals. The majority of people who have these will be in a lower tax bracket when they retire. This benefits them, as they will have to pay less tax on their money. Since the Traditional IRA is built for retirement, they have rules enforced to prevent you from withdrawing these funds early. If you withdraw these funds before age 59 ½, then you will be penalized 10% for an early withdrawal, along with having to pay income taxes on this money. Another thing to keep in mind that beginning at age 72 you must begin taking required minimum distributions, or RMDs. These RMDs are a percentage of your balance and life expectancy, and a 401K is set up the same way.

 

Now, the Roth IRA is roughly the opposite of the Traditional IRA. When you contribute to a Roth IRA, you do not get to deduct this amount from your personal income tax. However, when you withdraw these funds at retirement you are not taxed on these funds at all. Roth IRAs also do not have a required minimum distribution when you turn 72 like the Traditional and 401K. It is still set up for you to not withdraw from before age 59 ½. While there are a couple of minor exceptions to be able to withdraw from a Roth IRA before age 59 ½, these exceptions are worst-case-scenarios and only recommended to turn to as last resorts.

 

In addition, both IRAs have contribution limits each year based on your modified adjusted gross income (MAGI). Your MAGI determines if you qualify to contribute to an IRA or not. These limits can be found here: https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-contributions#:~:text=The%20annual%20contribution%20limit%20for,your%20filing%20status%20and%20income.

 

So which IRA is best suited for you? Some of this depends on your MAGI and which IRA you can contribute to. Your choice also depends on which tax brackets you are in now, as well as what you believe your tax bracket may be at retirement. If your employer offers a 401K through work, it may be the best option for you to invest with them in the 401K since the Traditional IRA is structured much like the 401K. That way you could also budget to invest in a Roth IRA as well. In this case you will have the best of both worlds. When you are 72 and they require you to begin taking an RMD each year, then you can do that from your 401K and not touch your Roth since it does not require a RMD. While you are pulling from your 401K, your Roth can continue to grow and build interest to get the most out of your retirement. Of course, this is a perfect world scenario and depends mostly on your financial situation at that time. With the life expectancy in America continuing to grow, an individual should take the proper steps in building a nest egg to last them through retirement.