Saving
With the intent of saving towards retirement, an Individual Retirement Account (IRA) provides a financial vehicle where you can deposit money and earn interest. IRA accounts offer tax benefits to the holder, although the two main types of retirement accounts, traditional IRAs and Roth IRAs, offer very different types of tax breaks.
An individual may deposit money into his or her IRA account any time before April 15 to obtain credit for the previous tax year.
Traditional IRAs
A traditional IRA offers a tax deduction for the investor for the year in which he donates to the account. The amount of the contribution to a traditional IRA is deductible from the amount of income the individual claims on his taxes. For example, if you made $50,000 of income in one calendar year and you deposited $2,000 into a traditional IRA account, you would only be taxed on $48,000 of income.
A traditional IRA limits the amount that an investor may deposit on an annual basis and this amount is subject to change. Check with your banker or an accountant each year before donating to your IRA.
When funds are withdrawn during the individual's retirement years, that amount is then subject to taxation as if it were regular income. In addition, early withdrawals may also incur a penalty.
Roth IRAs
Named after William Roth, the late senator who proposed this type of retirement account, a Roth IRA does not offer immediate tax benefits for the investor so it does not reduce the amount of income claimed on one's taxes. Like a traditional IRA, the funds in a Roth IRA may be invested in various financial vehicles, such as mutual funds, securities or certificates of deposit, or other investments.
The tax benefit to a Roth IRA is that withdrawals of the original investment during retirement years are not subject to taxation and there are no penalties for early withdrawals. In addition, investment earnings from a Roth IRA, although taxed, are subject to a lower, long-term capital gains tax rate, as opposed to a standard income tax rate, as long as the individual leaves the earnings in the account for at least one year.
Additional IRAs
Besides the traditional IRA and the Roth IRA, a few other IRAs exist for retirement savings. An SEP IRA allows an employer to open and donate to an employee's retirement account. A SIMPLE IRA allows employers to deposit a predetermined amount of an employee's income into the retirement account and the employer will then match that amount. These accounts are taxed on the same principal as a traditional IRA, although the employer making donations also realizes a tax deduction.
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