There was a time when Defined Benefit Pensions were the most common form of retirement plan, with employees paying into a pooled fund that was dispersed to an employee when they retire, the amount depending on the number of years they worked and their annual income from the job they had leading up to retirement. Those days are long gone, but that doesn’t mean the path to a great retirement is closed. Even if you don’t have access to an employer sponsored retirement plan, like a 401(k), you can still save for retirement, and gain some tax benefits in the process, by putting money in an Individual Retirement Account (IRA).
IRAs are a popular way to save for retirement outside of a plan through an employer. Money deposited into an IRA can be invested in fixed instruments such as IRA savings or certificates, or they can be invested in other options such as stocks, bonds, mutual funds, or annuities. The bottom line is you’ll be putting your money somewhere that’s intended to grow over time.
There are two main types of IRA – traditional IRAs and Roth IRAs. Each has its own set of rules and different tax benefits:
Many people who are not eligible for an employer sponsored retirement plan choose to make tax-deductible contributions to a traditional IRA. When you put money in a traditional IRA, you can’t withdraw it before you reach age 59 1/2 without paying a penalty, although there are exceptions. Some people consider this penalty to be a disadvantage, but it can make you think twice about touching the money, and help keep your retirement savings on track.
Traditional IRA contributions are not taxed as income until they’re withdrawn at the time of retirement. This can lower the amount of taxes an individual pays in the year the money is contributed, though when it comes time to withdraw the money it will be taxed as income.
The advantages of Roth IRAs are almost the opposite of traditional IRA benefits. You can’t make tax-deductible contributions to a Roth IRA, but the money you put in a Roth IRA grows not just tax-deferred, but tax-free. In other words, you won’t have to pay any federal taxes on your earnings when you take money out, provided you meet certain requirements. You are also less likely to have to pay a tax penalty if you withdraw money early from a Roth IRA.
With their tax-deferred status and ability to grow with investments, IRAs are a great way to keep you on track towards retirement. But what if you’ve already got a 401(k) through your job? An added benefit to all IRAs is you can put money in them even if you’ve got an employer-assisted 401(k). Having your money in different accounts could make your money more resilient to market fluctuations. Best of all, it becomes an additional source of income when you retire.
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