An individual retirement account (IRA) is an account you can create to set aside investment funds for your retirement. You can open these accounts at a variety of brokerage firms and banks where you choose the combination of investments right for you from a menu of stocks, mutual funds, CDs, money market funds and others. The two most popular IRAs are the traditional IRA and the roth IRA, each of which has both positive and negative features.
Traditional IRA Pros
Your contributions into a traditional IRA are tax-deductible in whole or in part, depending upon your adjusted gross income and whether you're also covered under an employer plan. Your earnings will continue to grow tax-deferred until the minimum retirement age (which was 59 1/2 in 2009), at which time you can make penalty-free withdrawals. Before that time, you can also make withdrawals that are penalty-free for a first-home purchase, college funds, disability or death expenses and some medical bills. It's a good retirement fund choice if you expect to find yourself in a lower tax bracket in retirement.
Traditional IRA Cons
One of the main selling points of the Traditional IRA is that contributions can be tax-deductible. However, if you don't meet the basic criteria, you may find that little to none of your payments are deductible. You can't withdraw any money from the fund prior to retirement (except for the options mentioned) without incurring a penalty and taxes. When you reach the minimum retirement age and start to withdraw money, you will be taxed at that time. You also can't continue to contribute after age 70 1/2 and must begin to withdraw money from the account when you reach that same age. The maximum amount you can contribute per year is capped at a limit set by the IRS (up to $6,000 in 2010).
Roth IRA Pros
Roth IRAs are generally more flexible in that they can provide some tax credit for contributions for eligible taxpayers, and you can withdraw your contributions at any time without paying any taxes or penalties if you've held the account for at least five years. Also, there is no age cap, 70 1/2 or otherwise, for either continuing to contribute funds or for mandatory withdrawals.
Roth IRA Cons
You must hold the account for at least five years to avoid penalties. Contributions are not tax-deductible through the life of the account, and you can't put any additional money into the account if your modified adjusted gross income (MAGI) is too high. As with the traditional IRA, the maximum amount you can contribute per year is capped (up to $6,000 in 2010).
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