What is an IRA? What you Should Know

Individual retirement accounts, or IRAs, are a good option for employees who wish to save for retirement. You can open an IRA if you have earned income, which is different from a 401(k), which your employer must offer for you to participate in. You can choose from a variety of IRAs, each with different features and requirements, but they all offer important tax advantages that may help you reach your savings goals.

Roth IRAs and traditional IRAs are the two types of IRAs that are most popular. You can contribute up to $6,000 to both accounts for 2021 if you are at least 50 years old by the end of the year. Choosing an IRA is not as difficult as you might think.

Traditional IRAs: What are They?

In a traditional IRA, you can grow your assets tax-deferred. In other words, until you begin taking distributions, your money grows tax-free. Then your withdrawals are taxed according to your income tax bracket.

The deduction for retirement plan contributions is available for 2021 only if your modified adjusted gross income is below $76,000 for single filers and $125,000 for married filers. If you do not have a workplace retirement plan but your spouse has one, the income limits are higher. You can deduct your contributions regardless of your income if neither you nor your spouse has access to a workplace retirement plan.

If you do not qualify for a Roth IRA (see next section), you may want to consider a traditional IRA if you expect to be in a lower tax bracket after retirement and if you plan to save outside your 401(k). If your employer offers a matching contribution to your 401(k), you should invest enough to get the full amount. Aside from that, IRAs may offer greater investment options than most 401(k) plans; however, it is best to study your 401(k) plan in detail first. Traditional Individual Retirement Accounts are available to anyone with earned income.

Although some exceptions may apply, generally you will have to pay income tax on any tax-deductible contributions and earnings that you withdraw from your traditional IRA before age 5912-Though some exceptions may apply.

What is a Roth IRA?

IRA accounts provide federally tax-free income in the future (state taxes may apply) for those who can afford to pay taxes now. IRA Roth contributions are not tax deductible, so you pay more taxes upfront than if you contributed to a traditional IRA that is deductible. You will, however, get to take home the full withdrawal amount tax-free when you withdraw your contributions. A Roth IRA contribution can be withdrawn at any time, tax-free (including the 10% early withdrawal tax) although a portion of it may be subject to taxes depending on the earnings component. This is unlike contributions to traditional IRAs that are deductible.

There are no permitted minimum distributions for Roth IRA owners while they are alive, another feature that sets them apart from traditional IRAs. For 2021, you are necessary to have earned income, with single taxpayers earning less than $140,000 per year, and joint taxpayers making less than $208,000 per year. These limits are adjusted yearly by the IRS.