There are a few different types of IRAs, but the two most popular ones are the Traditional IRA and the Roth IRA. The right choice for you depends on many different factors. Hereâ€™s the difference between the two popular IRAs and how Roth IRAs can work for you.
The main differentiator between Roth IRAs and Traditional IRAs is how theyâ€™re taxed. When you contribute to a Traditional IRA, all your money goes in tax-free. When you make contributions into a Roth IRA, that money is taxed now.
A Traditional IRA is a great option for those who want all their dollars to go toward investing as soon as possible. With Roth IRAs, you have to envision how your finances will look when you retire. Having taxes taken out now means they wonâ€™t be taken out again when you eventually make withdrawals. If youâ€™re expecting to earn more money by the time you retire, avoiding the tax penalties later on in life can mean significant savings.
Although putting money into a Roth IRA is taxed, you can take money out tax-free. For Traditional IRA accounts, you get taxed on withdrawals when youâ€™re eligible to make themâ€”which isnâ€™t a problem if youâ€™re earning less money later on in life. If however, youâ€™re hoping to earn more than you did at the beginning of your career, it might make more sense to stick with a Roth IRA.
Having the luxury to withdraw money without getting taxed means more money in your pocket in retirement. If you donâ€™t plan on working in retirement, youâ€™re going to need every dollar youâ€™ve invested
For some people, the older you get, the younger you feel. So if youâ€™re getting older and youâ€™re not interested in retiring anytime soon, you may still be interested in contributing to your IRA. If youâ€™re older than 70 and a half and you have a Traditional IRA, you canâ€™t make contributions because thereâ€™s a stopping point.
On the other hand, Roth IRA account holders can continue to make contributionsâ€”and withdrawalsâ€” as long as theyâ€™d like. Keep in mind that you may be penalized if itâ€™s before you turn 59 and a half years old. This applies to both Traditional and Roth IRAs; however, Traditional IRAs force you to start making withdrawals at 70 and a half â€” even if you donâ€™t want to.
If youâ€™re thinking about a Roth IRA, you might want to check your eligibility first. If you make more than $137,000 as a single filer or more than $203,000 filing jointly (2019), you wonâ€™t qualify for a Roth IRA. If thatâ€™s the case, a Traditional IRA might work best for you. If, however, youâ€™re below the threshold and want to get every dollar you can out of retirement, a Roth IRA might be the route to take.
You can convert to a Roth IRA if you donâ€™t meet the income requirements or if you held a Traditional IRA at some point in your life. Once you make this change, however, you canâ€™t go back to a Traditional IRA â€” permanently solidifying its status as a Roth IRA.
Converting a Traditional IRA into a Roth IRA is sometimes called a â€śbackdoor Roth,â€ť which is starting with one type of IRA and moving to the other. Keep in mind that youâ€™ll owe taxes on any pre-tax IRA contributions. Once you make the change, you canâ€™t take out any money penalty-free until at least five years after youâ€™ve converted your account.
Now that you know how Roth IRAs work, you may be ready to open one. You can go with an online brokerage account, which will help you manage your investments. Look for an account that has low fees and minimal opening balances. If you prefer more of a hands-off approach, consider a robo-advisor to help with your investing decisions.
Opening an account is only the first step. Youâ€™ll need to continue making regular contributions to ensure your investments are growing a consistent, steady pace. Whether you contribute every paycheck, month or year, adding money to your Roth IRA should always be included in your budget.
If youâ€™ve decided that a Roth IRA is best for your investments, make sure you choose an investment company wisely. You can go with an online brokerage â€” where you choose your investments yourself â€” or a robo-advisor that does it on your behalf. Just remember that you have options, and should always work towards increasing your wealth for as long as youâ€™re able to make regular contributions. Youâ€™ll be thanking yourself later â€” during retirement.
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