IRA is the acronym for individual retirement account. Two types of self-directed IRAs are traditional and Roth IRAs. An IRA is an investment for your future, although CNN Money indicates that the account in of itself isn't the investment, but rather describes it as a "basket" where you stash your assets--bonds, certificates of deposits, stocks, and mutual funds--and essentially anything that doesn't qualify as an "ineligible investment" as defined by the Internal Revenue Service, such as artwork, antiques and gemstones.
IRAs in General
CNN Money notes that most IRAs are self-directed--they are opened and managed by you, although in some cases, they may be opened by the self-employed on their own behalf or by small-business owners on behalf of employees. An IRA is funded by your contributions, which is capped at a certain limit and apply to either a traditional IRA or Roth IRA or combination of IRA types. According to 2010 IRA contribution limits, if you were under 50 years old at the end of 2009, the maximum contribution you can make is $5,000; if you turned 50 years old before 2010, you can contribute up to $6,000. Or, you can contribute the amount of your taxable compensation, whichever amount is smaller.
IRAs and Taxes
The most pronounced difference between traditional IRAs and Roth IRAs is where you get your tax benefit, notes CNN Money. If you have a traditional IRA, withdrawals are taxed when you take the money out, which is usually when you retire. Depending on your income level and if you receive a retirement plan through your employer, you may also be able to deduct the full amount of your contributions at the end of the tax year. But if you have a Roth IRA, you pay taxes up front. When you receive withdrawals, they are tax-free. However, you cannot deduct your Roth IRA contributions at the end of the tax year.
Distribution Differences
Traditional and Roth IRAs are subject to different rules of distribution. You can start getting distributions at age 59 1/2 if you have a traditional IRA, but are required to start receiving them by the time you reach age 70 1/2. If you have a Roth IRA, you never have to take distributions at all, and your account can continue to grow earnings as long as you want. If you never touch your Roth while you're living, it can be transferred, fully intact, to the beneficiary of your account, such as a spouse or child
Eligibility
Both types of IRAs impose different rules of eligibility. If you have a traditional IRA, your eligibility to contribute depends on your level of income or income tax filing status only if you are covered by another retirement plan, such as a 401k; however, you or your spouse cannot contribute to it once you reach age 70 1/2 no matter your income level, notes CNN Money. Roth IRAs do not impose such age restrictions, but if you make too much money, you might not be eligible to contribute to a Roth--or, you may be able to contribute at a reduced rate. Your eligibility also takes into consideration your tax filing status, as well. To see if you are eligible to contribute to a Roth IRA, see the Resources link.
Penalties
For your IRA to reach its full potential, it's best not to touch it before you reach age 59 1/2, advises CNN Money. If you do, you may be subject to penalties. However, these are applied to traditional IRAs and Roth IRAs differently. If you have a Roth IRA, you can dig into your contributions at any time; as long as you leave your earnings alone, you won't be subjected to a 10 percent tax penalty. But, if you take an early withdrawal from a traditional IRA, not only will you have to pay a 10 percent penalty, you'll be taxed on the amount you withdraw as though it is income. There are certain instances when you can safely withdraw the money from your IRA without incurring the 10 percent penalty, notes CNN Money, such as if you use the money to go to college, purchase a home for the first time, incur a large amount of medical expenses or become disabled.
Traditional to Roth
The IRS notes that you can convert a traditional IRA to a Roth IRA by rollover, trustee-to-trustee transfer or same-trustee transfer. However, if you convert your IRA, you will be taxed on the untaxed amounts in your traditional IRA--which can present you with a large tax bill. CNN Money indicates that conversion may be sensible if you suspect that you'll be paying the same amount of taxes (or higher taxes) after you retire. However, if you're closer to retirement age and expect to have less income once you're out of the workforce, it may be best to leave your traditional IRA alone.
Member Comments