What you need to know about IRAs.
Individual Retirement Accounts were established by the federal government, and given special tax treatment, primarily to encourage people to save for retirement. With an IRA, you can set aside a certain amount of money every year in a special account managed by a bank or other financial institution, or by a mutual fund, life insurance company, or stockbroker. IRA accounts can be invested according to your choice of investment options. Your money grows tax-deferred and in some cases even tax-free. While this article explains some of the different types of IRAs, you should consult with your own tax or financial adviser to see if a particular type of IRA is right for you.
If you are eligible for both traditional and Roth IRAs, how do you choose between the two options? Or how do you decide how to apportion your retirement savings between the two? Here are some questions to consider:
- How long do you expect to keep earning money? If you'll be working beyond age 70?, you will have to begin withdrawing from a traditional IRA and paying tax on those withdrawals, while still paying income tax on your compensation.
- What tax bracket do you expect to be in when you start withdrawing money? If you expect to be in a lower tax bracket than you are now, then a traditional IRA enables you to save money up front by deducting your contributions and put off paying some taxes until later.
- Do you plan to use up your IRA assets during your lifetime, or leave them to your heirs? A Roth IRA can be used for estate planning, to build up assets for those who will inherit. While a traditional IRA can be inherited, your heirs and beneficiaries would probably gain more from a Roth IRA. Without mandatory withdrawals, your account can keep accumulating income, tax-free, until your death, when it will pass to the person you've designated.
IRA contributions may normally be invested in mutual funds, annuities, CDs, stocks, or bonds. Which investment selection is most appropriate for you depends on your personal objectives and the amount of risk you wish to take. But one certainty applies to all types of investments: The sooner you invest, the larger your IRA will grow and the sooner you'll be on your way to a comfortable retirement. Talk with your tax or financial adviser about choosing the plan that's right for you.
Written with the help of licensed psychologist Jonathan Hefner, M.A. Mr. Hefner specializes in financial and legal counseling and is the Manager of Legal and Financial Services at Ceridian Corporation.
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