About 35% of adults do not have access to a 401k plan through their employers. People without access to an employer-sponsored retirement plan often look for other ways to invest for retirement.
If you fall into this category and have questions about your financial planning options, you might want to consider opening an individual retirement account (IRA).
An IRA offers a way to save money for retirement, but you can choose from a Roth IRA or a traditional IRA. Do you know the differences? If not, keep reading to learn about the primary differences between these options.
Pre-Tax Income vs. Post-Tax Income
IRAs offer a way to put money away for your retirement, and both allow you to contribute the same amount per year. The primary difference between the two is the way they affect your taxes.
A traditional IRA is a pre-tax income investment. This means that you can write off the amount you deposited in your account on your taxes. By doing this, it decreases your income, saving you money on taxes.
When you withdraw money at retirement, you will pay taxes on the money then. Your investment grows tax-free, though.
A Roth IRA is a post-tax income investment. You cannot write off the amount you deposit in your Roth IRA right now. Instead, you pay taxes on that income now.
When you withdraw money later on, you will not pay taxes, as you already paid them. As with a traditional IRA, your investment grows tax-free.
You can contribute up to $6,000 each year into your IRA. If you are 50 or older, you can contribute up to $7,000 per year.
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Eligibility Rules
The second main difference is the eligibility rules with your income. A traditional IRA does not have income limits, which means that you can use one no matter how much money you earn.
A Roth IRA, on the other hand, has income limits. If you earn too much money, you cannot use one. The current income limits are $125,000 for a single earner and $198,000 for a couple.
If you earn more money than these limits, you will only be able to use a traditional IRA. You can always use a savings account on top of an IRA, too, if you want to save more money.
Withdrawal Rules
The other main difference is the withdrawal rules. Traditional IRAs have stricter rules relating to when you can withdraw money from these accounts. In most cases, you cannot begin taking money until you are at least 59 1/2.
You can withdraw money from a Roth at any time, mainly because you already paid taxes on the money you deposited in the account.
Financial Planning Is Vital for Your Retirement
Are you looking for another way to save money? If so, an IRA might be right for you.
If you enjoyed this financial planning tip, you’ll probably like other articles on our blog. Check it out today!
