Planning for retirement can be stressful without a proper plan. Many companies offer retirement plans to employees, but an IRA (individual retirement account) is a great way to supplement employer-led investment programs. Two types of IRAs are Roth or traditional, and each has benefits and advantages over the other. Reviewing the details with each IRA will help find the account that fits your retirement and investment goals.
Function
Roth and traditional IRAs take advantage of compounding interest to save for the future and retirement. The compounding interest allows your account to grow much faster than a typical savings account, and regulations on both IRAs allow the money to grow tax free while it is in the account.
Features
Financial institutions, including banks, insurance companies and brokerage firms, may offer Roth and traditional IRA accounts. A Roth IRA does not have any initial tax advantages because the money invested has already been taxed. The traditional IRA offers initial tax advantages as the initial investment money has not been taxed, but the money will be taxed as ordinary income upon withdrawal.
Considerations
Consider your income level and age when choosing Roth or traditional. To open a traditional IRA, you must be younger than 70 1/2 years old at the end of the tax year when you contribute. Roth IRAs do not have any age restrictions. There are income limitations on Roth IRAs depending on your marital status and how you file your tax returns. If you are single, or file your tax return as "single," then your income must be below $110,000 per year. If you are married but file separate tax returns, then your income must be below $100,000 per year. The income levels goes up to $160,000 per year if you are married and file a joint tax return.
Benefits
Contributions are the amount of money you invest each year. There are restrictions on the contribution limits for both types of IRAs. As of 2009, if you are younger than 50 years old, your contribution limit for Roth and traditional IRAs was $5,000. If you split your contributions between a Roth and traditional, the combined contribution limit is also $5,000. If you are older than 50 years old, the contribution limit goes up to $6,000 per year. The same limit is in place for combined contributions.
Warning
Roth IRAs allow you to withdraw money at any time because you have already paid income taxes on the invested money. To withdraw money tax-free, you must have had the account for at least five years, you are at least 59 1/2 years old, have disability, are purchasing a new home or there was a death. Traditional IRAs allow you to withdraw when you turn 59 1/2 and require withdrawals when you reach 70 1/2. When you withdraw before 59 1/2, there will be a 10 percent federal tax penalty plus income tax.
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