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In this article, I’ll go over all the important aspects of Individual Retirement Accounts (IRAs). I’ll go over the differences between different IRAs and which is best for you. If you already have the basics of IRAs down and want to know where to open one, see my article on the best places to open an IRA here (my recommendation is TD Ameritrade’s IRA).
Individual Retirement Accounts are a type of Individual Retirement Arrangement, and the acronym IRA is used to describe both. For all intents and purposes, we’ll stick with discussing Individual Retirement Accounts and use IRA for short.
IRAs are an important long-term tool for growing assets that everyone needs to become familiar with. They can allow all of us obtain a better quality of life during our retirement years, especially now that Americans are living longer in today’s world.
With IRAs, your contributions can either grow on a tax-deferred basis (as with Traditional IRAs) or on a tax-free basis (as with Roth IRAs).
An IRA is a contractual arrangement between three parties:
- You (a U.S. person and taxpayer who earns taxable income from gainful employment,
- The Internal Revenue Service,
- and an IRA custodian which you choose to hold the assets of your IRA (i.e. stock broker, bank, credit union, or mutual fund company).
*Be sure to check out all the best brokerage bonus offers for IRAs here
Traditional IRA Vs. Roth IRA
Choosing between a Traditional IRA and Roth IRA depends on your particular situation, and factors such as:
- Age (i.e. time between now & retirement)
- Your income & expenses.
- Tax bracket now & after retirement.
- Returns (i.e. earnings on your contributions).
Most will tell you that in the long run, a Roth IRA beats a Traditional IRA. The big benefit of a Roth is that your withdrawals are Tax Free after 59.5 years of age. Another advantage of the Roth IRA over a traditional IRA is that there are fewer withdrawal restrictions and requirements.
Here’s a comparison table from the IRS website, you can also find it here.
Contributing to a Traditional IRA means you typically may deduct some or all of your annual IRA contribution directly from your taxable income. This may provide a cut in your marginal tax rate, but Congress has specific rules affecting taxpayers who work in a job where they are covered by an employer pension or 401(k) plan.
Contributions within the Traditional IRA grow on a tax-deferred basis, and are only taxable by the IRS (and most states) at the time funds are withdrawn (usually in retirement).
Contributing to a Roth IRA will receive NO tax deductions for your annual IRA contribution. The best feature, though, is that your contributions within a Roth IRA grow on a tax-exempt basis, based on the current tax laws which would allow all earnings to be withdrawn in retirement free of tax liability.
Important: While current tax laws state that Roth IRA assets can grow totally exempt from taxation, some worry about whether or not U.S. Congress may change the tax-free status of funds within an IRA. From numerous past U.S. Supreme Court rulings, the United States Constitution does not prevent Congress from changing the Internal Revenue Code that can affect the tax status of either Roth or Traditional IRAs.
Roth IRAs have more benefits for the long-term, but if you need the immediate up-front tax deduction in order to make a full IRA contribution for the year, then the Traditional IRA is certainly better than making no IRA contribution at all.
Most Important Articles To Read About IRAs
In regards to IRAs held by a creditor during bankruptcy: On April 4, 2005, the U.S. SUPREME COURT issued a unanimous ruling determining that Congress intended for IRAs to be sheltered from creditors during a bankruptcy proceeding. Here are some articles of interest:
Important articles from the IRS website:
- IRS overview of Individual Retirement Arrangements
- IRS – Contribution Limits for IRAs
- IRS – IRA Deduction Limits for Traditional IRAs
- IRS – Rollovers of Retirement Plans and IRAs
- IRS – Rules regarding distributions
- IMPORTANT – new IRS one-rollover-per-year restrictions
- IRS – information on employer-based IRAs – Simple IRA etc.
- IRS – Savers’ Credit for lower-income taxpayers
- IRS – Publication 590 (2013 version) – Individual Retirement Arrangements
- IRS Publication 590 – Individual Retirement Arrangements
- IRS Retirement Tax Information Site
Where To Open An IRA Account…
Here are a few places you can open an IRA account at: