The acronym "IRA" stands for Individual Retirement Account. It is a type of savings account in which you can place assets, such as mutual funds and stocks. Most IRAs are individually opened, as opposed to work-sponsored accounts, such as 401(k) accounts. Not all IRAs are the same; each type of IRA comes with its own set of eligibility requirements and contribution limits. Two popular IRAs are the Traditional IRA and the Roth IRA.
Definition
A Traditional IRA is a retirement account that allows you to save earnings and deductible contributions without having to pay income taxes on them until money is withdrawn upon retirement. A Roth IRA is also a tax-exempt retirement savings account, but the taxes are only deducted when money is contributed to the account. Upon withdrawal (typically upon retirement,) distributions are tax-free.
Advantages
The primary advantage of having a Traditional IRA is that the amount of tax saved when money is contributed to the account could put you in a lower income tax bracket. When you retire, your income may be lower anyway, offering you a lower tax rate when you withdraw the money. The primary advantage of having a Roth IRA is that withdrawals are tax-free and there are no minimum withdrawal requirements.
Disadvantages
The biggest disadvantage of having a Traditional IRA is that you must withdraw a certain amount of your funds after a certain point even if you don't find it financially necessary. Another disadvantage of having a Traditional IRA is that you have very little way of knowing what your tax rate will be once you retire. If ends up being high, you lose out. The major disadvantage of having a Roth IRA is that you may not qualify for one if you don't fall into the right income bracket.
Withdrawal Requirements
If you are a Traditional IRA account holder, you can start to withdraw from your account at age 59 1/2. At this point, your withdrawals are taxed as though they are your regular income. Penalties are typically harsh if you withdraw before you are 59 ½ years of age. If you have a Roth IRA the minimum withdrawal age is 59 ½. You can withdraw the principal at any point without being penalized, but any accrued earnings must stay in the account or else you will pay taxes and penalties.
Minimum Distributions
You must make a minimum withdrawal every year by age 70 ½ if you are the owner of a Traditional IRA, or else you will be penalized. Such is not the case if you have a Roth IRA. There is no minimum distribution rule for Roth IRAs.
Income Limits
Though everyone is eligible to make contributions to a Traditional IRA, not everyone will benefit from associated tax deductions. If you have a Roth IRA as a single person, you may no earn more than $95,000 annually; if you are married, you may earn up to $150,000 per year.
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