What are IRA's?
IRA stands for Individual Retirement Account, and it's basically a savings account with big tax breaks, making it an ideal way to sock away cash for your retirement. A lot of people mistakenly think an IRA itself is an investment - but it's just the basket in which you keep stocks, bonds, mutual funds and other assets.
Unlike 401(k)s, which are accounts provided by your company, the most common types of IRAs are accounts that you open on your own. Others can be opened by self-employed individuals and small business owners. There are several different types of IRAs, including traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs.
Unfortunately, not everyone gets to take advantage of them. Each has eligibility restrictions based on your income or employment status. And all have caps on how much you can contribute each year and penalties if you yank out your money before the designated retirement age.
Scroll down to see the different types of IRA's
Comparison between Annuities, 401(k) and IRA's
HOW ARE THEY TAXED?
WHAT IS A TRADITIONAL IRA?
A traditional IRA is a tax-deferred retirement savings account. You pay taxes on your money only when you make withdrawals in retirement. Deferring taxes means all of your dividends, interest payments and capital gains can compound each year without being hindered by taxes - allowing an IRA to grow much faster than a taxable account.
Traditional IRAs come in two varieties: deductible and nondeductible. Whether you qualify for a full or partial tax deduction depends mostly on your income and whether you have access to a work-related retirement account like a 401(k).
Compare a Trad IRA vs ROTH IRA
WHAT IS A ROTH IRA?
A Roth IRA is a retirement savings account that allows your money to grow tax-free. You fund a Roth with after-tax dollars, meaning you've already paid taxes on the money you put into it. In return for no up-front tax break, your money grows and grows tax free, and when you withdraw at retirement, you pay no taxes. That's right - every penny goes straight in your pocket.
There are a few other benefits too.
How is a Roth IRA different from a regular IRA?
The main difference between the two types of IRAs is when you pay taxes on your investments. Traditional IRAs can delay the taxes until retirement, but with Roth IRAs, you pay tax now rather than later.
Here's how it works: With a Roth IRA, there is no up-front tax break, but you don't have to pay tax on withdrawals in retirement. That's the opposite of a traditional IRA, which may allow you to deduct at least part of your contributions if you qualify, but requires you to pay income tax on money you withdraw in retirement. Both accounts allow investments within them to grow without getting clipped by taxes each year.
There are other differences too.
Roth IRAs offer a bit more flexibility than traditional IRAs do. You may withdraw your contributions to a Roth IRA penalty-free at any time for any reason (but you'll be penalized for withdrawing any investment earnings before age 59 ½ unless it's for a qualifying reason). If you converted money from a traditional IRA into a Roth IRA, you can't take it out penalty-free until at least five years after the conversion.
Roth IRAs also let you leave your money untouched for as long as you like. With a traditional IRA, you must start making withdrawals called "required minimum distributions" after you reach age 70 ½. And while you can no longer make contributions to a traditional IRA after you have turned 70 ½, you can keep contributing to a Roth IRA regardless of your age.