IRAs (individual retirement accounts) are a way to save your money long-term while experiencing tax advantages. Many people use an IRA to build a nest egg that they can use once they retire.
You might get access to an IRA through your employer. However, most people will manage their IRAs. Traditional IRAs have been available since 1974. Roth IRAs came on the scene in 1997. While both share similarities, some distinct differences could impact your choice.
An Overview of a Traditional IRA
The cash you contribute to a traditional IRA can be deducted against your state and federal taxes. When you withdraw money, you are taxed based on your income tax rate at the time of the withdrawal.
In most cases, contributing to an IRA lowers your taxable income for the year that you contribute. Since your adjusted gross income is reduced, you might qualify for things like student loan interest deduction or child tax credits that you would not have qualified for before.
Any money you withdraw from a traditional IRA before you are 59.5 years old will be taxed and have a 10% early withdrawal penalty. There are certain circumstances where you can avoid the penalty, but you will always pay the tax.
An Overview of Roth IRAs
When you contribute toward a Roth IRA, it does not lower your AGI. However, any money you withdraw from your Roth IRA after retiring is tax-free. This is because you paid the tax at the outset, so you don’t owe anything later.
To participate in a Roth IRA, you need to have a MAGI of under $144,000. Married couples need a modified AGI of less than $214,000.
Since you are not required to withdraw cash from a Roth IRA at any time, you could leave it to your children as a tax-free wealth transfer vehicle. You can withdraw money from your Roth IRA contribution equal to the amount you contributed without penalties or taxes at any time.
Important Differences between Roth and Traditional IRAs
If you are looking to open an IRA account with SoFi, it is good to familiarize yourself with the differences between Roth and traditional IRAs. According to the financial experts at SoFi Invest, “IRA is a broader term of several different types of retirement accounts – each with their own function and purpose.”
The most significant difference between these IRA types is when you will get tax benefits. Also, anyone can open a traditional IRA, but there are financial limitations on who can open a Roth IRA.
With a Roth IRA, you are never forced to take withdrawals. However, you have to start taking RMDs, which are mandatory taxable withdrawals, with a traditional IRA when you hit 72 years old.
If you withdraw cash before 59.5 years of age with a traditional IRA, you experience penalties. With traditional IRAs, you can withdraw your contribution penalty tax-free whenever you want.
Investing in IRAs
The two types of IRAs are administered the same. Your brokerage can act as a custodian for your traditional and Roth IRA with similar fees and minimums for each.
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