What is an Individual Retirement Account (IRA)?
Many financial experts will tell you to plan for retirement. But how? An individual retirement account (IRA) is a great option to supplement your company’s 401(k) (or other employer-provided retirement plan) or as a personal way to take control over your personal retirement plans. The biggest question is Roth or traditional? The answer is, “It depends!” Both traditional and Roth IRAs offer tax advantages but there are some slight differences.
Differences Between a Traditional and Roth IRA
Here is a table to break down some of the differences between these two retirement accounts.
|Roth IRA||Traditional IRA|
|Is there a contribution limit?||Yes–$5,500 ($6,500 if you’re older than 50)||Yes–$5,500 ($6,500 if you’re older than 50)|
|Is this limit more or less than a 401(k) contribution limit?||Contribution limits are lower than a 401(k)||Contribution limits are lower than a 401(k)|
|When are you taxed?||Your money is taxed going into the account. You will not pay taxes when you retire and begin taking out money. If you expect the tax rate to be higher when you retire then this is an attractive option because you’ve already paid taxes.||Your money is taxed when you withdraw from the account. If you expect your tax rate to be lower in the future (when you retire and your salary has already peaked) then this is attractive to you.|
|Are there penalties for taking money out early?||No—you already paid your taxes so you can take out the money before you retire.||Yes—If you take out money before 59 ½ years old you’ll pay taxes and a 10% penalty.|
|Do I have to take out the money?||No—You are not required to take out any money. This allows you the flexibility to pass along the money to family members. You can also use the money to pay for some qualified college expenses to supplement or even substitute for a 529 plan.||Yes—you must begin taking out minimum distributions (taking out money) at age 70 ½. At that same age you can no longer contribute to the account.|
Make a Plan for Retirement
In general, planning for retirement is better than not planning. Either option above is better than not having some sort of retirement account and plan. However, many experts also suggest that employer provided retirement accounts, specifically ones with matching options, are the first place to start and max out before starting an IRA. So, no need to decide between an IRA and 401(k) plan because both will help you achieve your retirement goals.