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ira benefits

If you’re thinking about opening a traditional individual retirement account (IRA) or Roth IRA, you have some major tax benefits to look forward too. However, these aren’t one-size-fits-all accounts. This article will explain the benefits and disadvantages of traditional IRAs and Roth IRAs to help you make the right retirement planning decisions. We can also help you find a financial advisor who can help you create a retirement savings plan based on your individual needs.

What Is an IRA?

An IRA functions similarly to a 401(k) plan, but you don’t need to work for a company that offers one to get it. You can open one at a bank or through most financial institutions. It also provides several tax benefits.

For starters, you can make tax deductible contributions to an IRA. In 2022, as with 2021, you can contribute up to $6,000 toward an IRA. So that means you can reduce your taxable income by as much. And if you’re at least 50-years-old, you can make “catch-up” contributions of up to an extra $1,000.

In addition, your investment grows tax free while it’s in the account. So you won’t get taxed on any interest, dividends or any other gains your account earns.

However, you will be taxed once you start making eligible withdrawals. You can do so once you turn 59.5. This isn’t the case with a Roth IRA.

What Is a Roth IRA?

Unlike with traditional IRAs, you invest in a Roth IRA with after-tax dollars. In other words, it doesn’t reduce your taxable income. The trade-off, however, is that you can make tax-free withdrawals once you turn 59.5 as long as you’ve had the account open for at least five years.

Still, your earnings grow tax free while your money is in the account. And as with IRAs, their Roth counterparts allow you to invest in just about any stocks, bonds, exchange-traded funds (ETFs) and mutual funds you want.

In fact, the investment options for a traditional IRA or Roth IRA tend to be far more vast than the ones available to you through a 401(k) plan.

Who Should Get a Traditional IRA?

IRA benefits

Investing in a tax-deferred account such as a traditional IRA makes sense if you expect to find yourself in a lower tax bracket as you approach retirement. That way your withdrawals get taxed at a lower rate than, say, the one you pay now. But if you intend to work or earn more money the closer you get to your golden years, the Roth IRA may be a better option.

Who Should Get a Roth IRA?

You can make eligible withdrawals from a Roth IRA tax-free once you reach age 59.5. The only other condition is that your account must have been open for at least five years. So you can’t immediately roll over your IRA money into a Roth option and begin enjoying the tax break.

But if you expect to be in a higher tax bracket when you retire, this can prove a beneficial option.

Disadvantages of IRAs and Roth IRAs

Unlike with Roth IRAs, you have to start taking your money out of its tax-sheltered status eventually. In fact, you have to start taking required minimum distributions (RMD) when you turn 72.

RMDs don’t apply to Roth IRAs as long as you’re alive. However, your beneficiaries must take RMDs at some point depending on their relation to you.

The Takeaway

ira benefits

When it comes to retirement planning, the best choice you can make is to start saving right now. And both traditional IRAs and Roth IRA are excellent vehicles to build your retirement nest egg. Both offer tax benefits, but one may be better for you depending on your circumstances. Generally speaking, if you expect to be in a higher tax bracket when you retire, a Roth IRA may be a better option. Still, there’s no rule stating you can’t have both.

Tips on Retirement Planning

  • If you want to transfer your savings into a traditional IRA or a Roth IRA, check out our guide on how to rollover a 401(k) into an IRA.
  • Opening either a traditional or Roth IRA can be a great decision, but managing it properly can be a challenge. Luckily, you can work with a professional financial advisor who can help guide you through the entire process. We can help you with our interactive find a financial advisor tool.
Javier Simon, CEPF® Javier Simon is a banking, investing and retirement expert for SmartAsset. The personal finance writer's work has been featured in Investopedia, PLANADVISER and iGrad. Javier is a member of the Society for Advancing Business Editing and Writing. He has a degree in journalism from SUNY Plattsburgh. Javier is passionate about helping others beyond their personal finances. He has volunteered and raised funds for charities including Fight Cancer Together, Children's Miracle Network Hospitals and the National Center for Missing and Exploited Children.
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