It's important to start saving for retirement early. The good news is that even if you already have a 401(k) at work, you can give your savings a boost with an Individual Retirement Account (IRA). An IRA, which combines the benefits of compound interest and tax savings, is available to anyone who earns taxable income. You can open an IRA at virtually any financial institution, including your bank, and opening fees are generally lower than other investment accounts.
While it's relatively easy to open an IRA, figuring out which type is right for you can be confusing.
There are two types of IRAs - traditional and Roth. With a traditional IRA, your income is taxed when you start making withdrawals, and you generally incur a penalty if you withdraw money before age 591/2. With a Roth IRA, you can withdraw your earnings tax-free after age 59½ as long as you've owned the account for at least five years. In other words, income from a traditional IRA is tax-deferred, while income from the Roth IRA is tax-exempt.
Another important difference is that you must start taking withdrawals from a traditional IRA at age 70.5. There is no mandatory distribution age with a Roth, but there are income restrictions. Single filers with an adjusted gross income of $110,000 or more and couples with a joint return of $160,000 or more cannot open a Roth. Traditional IRAs, on the other hand, have no income restrictions.
That explains a bit about the money you take out of an IRA, but what about the money you put into it? Contributions to a traditional IRA may be tax deductible depending on your income level, but if you are eligible to participate in your employer's retirement plan, you may not be able to deduct all of your contributions. On the other hand, Roth IRA contributions are never tax deductible, but the earnings are tax exempt if they are part of a qualified distribution.
The federal government imposes new IRA contribution limits each year. It's generally a good idea to make the maximum contribution. The good news is that contribution limits have increased since 2002 and continue to increase, so there's never been a better time to open an IRA.
