What’s The Difference?
Many adults can’t even answer this question!
This post comes directly from a comment left by a reader in a previous article. That person wanted me to explain the difference between a Roth IRA and Traditional IRA, as well as explain how to open one, where to open one, and how much to contribute to one.
All of those questions would make for an extremely lengthy article. Instead, I’ll be breaking it into a few posts. Today, I’m going to just start by explaining the difference between the two. This is really easy for me to answer and may seem obvious for those who know about them. But for many college students (and adults for that matter), retirement accounts are a topic everyone seems to have questions about.
Retirement! Only 40+ years away
I’ve indirectly explained the significance of starting to save for retirement at a young age in another article on compound interest. If you haven’t seen that, it might help to start there. Click HERE to read all about compound interest.
I will end up explaining more in-depth the importance of saving for retirement in your 20’s in another article. It’s really just important to start a ground zero if you will, and explain what the benefits and cons to these accounts are.
What is an IRA?
IRA stands for Individual Retirement Account. Meaning that you, the owner of the account, are solely contributing to the account and receive no contributions (help) from an employer. IRA’s are in contrast to a 401(k) retirement account that an employer typically provides where they contribute money in addition to what you contribute. I will explain more about 401(k)’s in the future.
Why Would I Need One If I Will Have a 401(k) From My Work?
This also seems to be a question that pops up a lot. The quick answer to this is so you can save additional funds for retirement outside your employer and possibly get better returns on the money you invest. In a lot of employer given 401(k) plans, there is a limited number of investments you can choose from. Employers set it up for employees to select from a smaller number of funds they have chosen. They do this to reduce costs on their end and also provide lower fund fees for you. Because this article isn’t about 401(k)’s, that’s all I’ll say about them in this post. If you want to know more, definitely research it or drop me a comment below!
An IRA is an account set up at a financial institution that allows an individual to save for retirement with tax-free growth or on a tax-deferred basis. Money put into an IRA is from your own income after taxes. This money you’re putting in is on a post tax basis, meaning it is income that has already been taxed just like all your other money. This is in contrast to a 401(k) that allows you to put money into it before taxes are taken out.
With a Traditional IRA, you make contributions with money you may be able to deduct on your tax return. Any earnings potentially grow tax-deferred until you withdraw them in retirement. All the money you make on your investments will not be taxed up until when you retire. Traditional IRA contributions are also tax-deductible on your tax returns for the year you put money in. So you’ll end up getting some savings on your taxes for doing this. To learn more about this, click HERE.
-Tax deferred earnings you won’t pay until you take money out during retirement
-Tax deductible on your taxes each year you contribute to the account
-Contribute $5,500 a year to one of these bad boys, regardless if you’re rich or poor
-You’ll end up paying taxes at the end when you retire which will definitely decrease your money for retirement
These are great for young people. Here’s why.
With a Roth IRA, you make contributions with money on which you’ve already paid taxes. Your money can then potentially grow tax-free, with tax-free withdrawals in retirement, provided that certain conditions are met.
What this means for you is that just like a normal IRA, you contribute money after taxes to the account. But when you withdrawal during retirement, there is NO TAXES. NONE. You keep all the money.
No taxes! What’s the catch?
The catch is you have to meet certain income requirements. You have to make less than less than $132,000 a year if you’re single (it’s higher for married couples filing taxes together). This is why they’re so great for young people. Early in your career, it is doubtful you’ll be making over $100,000 a year. Where as later in your career, it is possible that you may not qualify for one of these if you’re making the big bucks. Which YoungMoney really hopes you do.
– Tax free withdrawals
-Contribute $5,500 a year to one of these, but only if you’re making less than 132k a year
-After five years, up to $10,000 of earnings can be withdrawn penalty-free to cover first-time homebuyer expenses
-Money put into these are NOT deductible on your income taxes
-Have to make less than 132k a year to be eligible
Which One Is For Me?
There are pros and cons to both as you can see. But at a young age, many experts recommend contributing to a Roth, especially if you expect to not qualify for it later on. You can always switch to making an IRA account later on. Also to keep in mind is you can contribute to both if you like. However, that $5,500 annual contribution limit from the IRS isn’t per account. It is in total. Meaning you can only contribute 5,500 to any IRA in one given year. If you put 5,500 in a Roth one year, you’re maxed out and can’t contribute to a regular IRA that year.
I can’t tell you which is for you, but if you’re interested in reading more about them here is more info from Fidelity. Click HERE.
Hope That Helps!
Hope that gives you a better understanding of them. If you have any questions, comment section is below and you can comment anonymously.
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See you next week!